What is inflation?
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You've certainly heard of inflation, probably in a bad way. And you might know how it works, in some way. Basically, inflation is the rise of prices. Is it good or bad? It depends on the situation.
Imagine receiving your salary in the morning, and by the evening you cannot buy the same things you could in the morning with the same amount of money, because prices have raised absurdly in just a few hours. In Hungary, in July 1946, the prices would double every 15 hours. It's the most extreme case, the highest hyperinflation ever registered to date. This means that if you are paid your salary of $ 1.000 at 8 am, and the bike you want to buy costs $ 200 at the same moment, by 11 pm the bike costs $ 400, and you still have only $ 1.000.
You decide to sleep on the idea of buying the bike. You wake up, go to work, leave work and go to the bike shop at 2 pm on the day following your payment. Now, the same bike costs $ 800, and you still have only $ 1.000! You think this must be a mistake, and you decide to wait until the next day. This time you pass by the bike shop at 5 am, just before work, and not only it wasn't a mistake, but now the bike costs $ 1.600! You look at the price tag once again to be sure, then check your wallet and you see the same $ 1.000. You go to work, later visit a friend, and on the way back home, at 8 pm, stop by the bike shop once more. WHAT THE HELL, $ 3.200???
In only 60 hours (2,5 days), the bike price raised by 16 times, or 1500%. Meanwhile, your salary stayed the same. That is why people started throwing their Pengล banknotes on the floor, money was simply worthless.
The causes of inflation are various. If you study different cases of hyperinflation around the world, you'll find different root causes: wars, out-of-control expenditures, high governmental debts, political instability, wild money printing, etc., but it usually comes down to bad decisions being made. These bad decisions not only cause inflation to keep growing, they often accelerate the growth.
It's comparable to throwing water on burning oil: the intentions are good and you hope to control the problem; however, you just made the problem bigger, and now the whole kitchen is on fire and you have no idea how to stop it. You call your friends to help, and they sit down and come up with a plan: let's put out the fire with orange juice! It seems obvious the fire will continue growing, but history repeats itself.
Let's go back a bit to the Hungarian Pengล example. Let's say you're the bike shop owner. You paid $ 300 in bills (electricity, water, heating, etc.) last month. This month, all prices are rising. You went to the bakery yesterday and paid $ 5 for breakfast. This morning, the same breakfast costs $ 8, and by tomorrow morning it will be $ 12,8. In just a week, the same breakfast raised from $5 to $ 83.88. The same happened to lunch, dinner, the tram ticket price, and many other small things you have to pay every day. When you think you've had enough, this month's bills cost you $ 398.768.398,74 (three hundred and ninety-eight million, seven hundred and sixty-eight thousand, three hundred and ninety-eight Pengล and seventy-four cents). You have no other alternative, but to keep raising the prices of your bikes.
Inflation is usually not a problem, and it is good for a country if it is well-controlled; the problem is when it gets out of hand. A generalized rise in prices triggers human behavior: people stop spending, and businesses (remember that business decisions are taken by people) rise their prices, causing a never-ending loop. You can also imagine that businesses might create fewer jobs, fire more people and hire people at lower wages because of high inflation.
If prices are growing moderately, businesses will have incentives to keep investing, and so will create more jobs. Simultaneously, banks and other institutions can reduce the amount of money available for lending, since the return on investment will be lower. Therefore, if prices aren't growing, the economy might have slower or inexistent growth. This brings us to other three good topics for different posts: how recessions and crises happen, why is deflation (a constant fall in prices) a bad thing, and why keeping prices artificially low is a bad idea.
Learn more:
Adam Fergusson - When Money Dies: The nightmare of the Weimar Hyper-Inflation - buy on Amazon.de, Amazon.com
โ What is inflation?
Inflation is when prices rise. You have $ 100 and buy a book that costs $ 10. One year later, the same book costs $ 11. However, during hyperinflation, after only a few days the same book would rise from $ 10 to $ 90.
Bad decisions (usually by governments) cause prices to go up, and worse decisions (trying to fix the problem) make the prices go even higher.
When prices rise, people tend to save money, and businesses tend to rise their prices, causing a loop. Since people are saving money and companies are spending more on their bills, fewer jobs will be offered.