Inflation

Financial Dictionary -> General Finance -> Inflation

Inflation (the opposite of deflation) is a general rise in prices across a wide range of goods and services. It can be described as a loss in the purchasing power of money, meaning in theory you can no longer buy what you used to with the same amount of cash.

During times of extreme inflation there is an equal decrease in demand as people can no longer afford things. Therefore rising inflation means lower consumer spending and can lead to an economic recession.

That being said, in a successful economy as prices rise so do wages and therefore the ratio is evened out and people can still afford the same products, it will just take more physical money. Therefore a truer definition of inflation is the falling value of a country's currency.
The fear of inflation comes when wages do not rise in ratio or do not rise at all. Extreme cases of inflation are known as hyper inflation. In Germany in 1923 inflation was at an astounding 1,000,000% and the public literally had to carry around trunks full of money just to buy a loaf of bread. In fact some say it was more cost worthy to burn money instead of buying coal.

So that the economy stays steady governments try to keep a constant rate on inflation each year. They may also manipulate inflation to manage consumer demand. Doing this keeps the economy fro having a massive boom or a major recession.

Uncertainty or speculation about inflation can cause a reluctance to invest and lead to economic problems just on the myth that something may happen, even if it doesn't.

The use of the term inflation today shouldn't be confused with the old use of the word, which referred to the physical increase of the monetary supply in an economy.