What is inflation?

09. February 2023
Michal Hladký

What is inflation, how does it work, and how to stop it? These are some of the most common questions everyone has been asking themselves in recent months. However, inflation does not only determine the rate at which money loses value. Everyone can feel its effects, most notably in the rising prices of various types of goods.

Definition of inflation

Everyone talks about inflation, and everyone has heard of it, but what is the true definition of inflation? To put it simply — it is the loss of value of the currency over time. The consequence is that we buy less for the same money than before. In the case of positive inflation, prices and services rise simultaneously. 
 

Investments are an effective tool to hedge against inflation. Read more in the article we wrote on this topic.

Measuring inflation

The development and measurement of inflation is the responsibility of the reservre bank or other local regulatory body in the given country (for example Federal Reserve System or simply "the Fed" in the United States), which then also publishes the resulting values. The published value of inflation is reported in these statistics as year-on-year. It therefore shows how much the given currency has weakened over the past twelve months. Depending on the type of inflation, the relevant index is then published. The Consumer Price Index (CPI) is among the most well-known.

Walking on thin ice
Although inflation has recently been perceived by the overwhelming majority quite negatively, its healthy level is necessary for the proper functioning of the current system. If inflation falls to negative values, we are then talking about so-called deflation, which can have similarly harmful effects on the economy. All major national reserve banks therefore take profound care of keeping inflation within the necessary limits.

What it looks like when inflation gets out of control? This can be seen currently in several countries across the globe, some reaching values that are difficult for many to even imagine. This includes, for example places like Turkey, Argentina and Venezuela. Some sources even claim that namey in Venezuela, the highest measured inflation was 13,380% (Yes! A whooping thirteen thousand percent!).
According to the values that inflation reaches, it is usually divided into the following variants:

  • Creeping Inflation: Mild inflation or moderate inflation. This type of inflation occurs when the price level persistently rises over a period of time at an acceptable and steady rate. When the rate of inflation is less than 10 per cent annually, or it is a single digit inflation rate, it is considered to be a moderate inflation.
  • Galloping Inflation: If inflation gets out of control, it may assume the character of galloping inflation. Inflation in the double or triple digit range of 20, 100 or 200 percent a year is called galloping inflation. Many Latin American countries such as Argentina, Brazil had inflation rates of 50 to 700 percent per year in the 1970s and 1980s.
  • Hyperinflation: Nothing good can be said about a market economy in which prices are rising a million or even a trillion percent per year. Hyperinflation occurs when the prices go out of control and the monetary authorities are unable to control it whatsoever either due to bad financial policies or even blatant incompetence. Germany had witnessed hyperinflation in 1920's, also previously mentioned country of Venezuela is one of today's prime examples of this phenomenon.
  • Stagflation: When inflation and economic stagnation (or recession) occur simultaneously and remain unchecked for a certain period of time. Stagflation hit most developed countries in 1970s, during world oil crisis.
  • Deflation: Basically the opposite of inflation. It refers to a sustained decline in the price level of goods and services. It occurs when the annual inflation rate falls below zero percent (i.e. negative inflation rate), resulting in an increase in the real value of money. Japan faced deflation for almost a decade in 1990s.

Inflationary spiral

An inflationary spiral is sometimes also called a price spiral. It takes place at a time when rising inflation creates pressure to increase wages, which comes from unions or employees who want to compensate for rising costs of goods.

Cryptocurrencies and Inflation

It is no coincidence that the countries most affected by uncontrollable inflation are also among those in which cryptocurrencies enjoy the greatest popularity. Therefore, citizens of Russia or Turkey have a strong presence in the international crypto community. Crypto is also quite popular in South America. Not only ordinary savers are affected, but all entities. It is therefore no coincidence that last year two football clubs coming from this continent tried to transfer a player using cryptocurrencies.