inflation, in economics, persistent and relatively large increase in the general price level of goods and services. Its opposite is deflation, a process of generally declining prices. The U.S. Bureau of Labor Statistics produces the Consumer Price Index (CPI) yearly, which measures average price changes in relation to prices in an arbitrarily selected base year. While the CPI is usually considered the most reliable estimate of inflation, some economists have questioned whether it overstates inflationary trends.
Inflation results from an increase in the amount of circulating currency beyond the needs of trade; an oversupply of currency is created, and, in accordance with the law of supply and demand, the value of money decreases. Deflation is brought about by the opposite condition. In the past, inflation was often due to a large influx of bullion, such as took place in Europe after the discovery of America and at the end of the 19th cent. when new supplies of gold were found and exploited in South Africa. In modern times wars have been the most common cause of inflation, as government borrowing, the increase in the money supply, and a diminished supply of consumer goods increase demand relative to supply and thereby cause rising prices.
Inflation stimulates business and helps wages to rise, but the increase in wages usually fails to match the increase in prices; hence, real wages often diminish. Stockholders make gains—often illusory—from increased business profits, but bondholders lose because their fixed percentage return has less buying power. Borrowers also gain from inflation, since the future value of money is reduced. Deflation, which historically has occurred in the downward movement of the business cycle, lowers prices and increases unemployment through the depression of business. Persistent deflation in Japan, beginning in the early 1990s, resulted in a drop in consumption, record unemployment, and general economic stagnation. Deflation in home prices after the financial collapse of 2008–9 (as opposed to deflation in goods and services prices) significantly reduced the value of the assets of many American households and proved a significant strain on the U.S. economy. An unusually steep and sudden rise in prices, sometimes called hyperinflation, may result in the eventual breakdown of an entire nation's monetary system. Among the notable examples of hyperinflation have been Germany in 1923, Yugoslavia in 1993–94, and Zimbabwe in 2008.
In the United States, annual price increases of less than about 2% or 3% are not considered indicative of serious inflation. During the early 1970s, however, prices rose by considerably higher percentages, leading President Nixon to implement wage-and-price controls in 1971. Stagflation–the combination of high unemployment and economic stagnation with inflation–became common in the industrialized countries during the 1970s. The costs of the Vietnam War and the social programs of the Johnson administration, plus the oil prices increases in 1974 by the Organization of Petroleum Exporting Countries (OPEC), contributed to U.S. inflation. By the end of the 1970s the Federal Reserve raised interest rates in an attempt to reduce inflation. Following a recession in the early 1980s, there was renewed growth, somewhat lower interest rates, and a decrease in the inflation rate.
During the early 1990s, a downward business turn created an international recession—without significant deflation—that replaced inflation as a major problem; the Federal Reserve lowered interest rates to stimulate economic growth. The mid-1990s saw moderate inflation (2.5%–3.1% annually), even with an increase in interest rates. By the late 1990s, U.S. inflation was low (1.9% by 1998), despite record growth; it tended to be somewhat higher (roughly 2%–3.5%) in subsequent years, due largely to increases in energy costs and, to a lesser degree, to large government deficits since 2001. Beginning in 2009, however, recession and a lackluster recovery led to much lower rates (typically less than 2%) and even to minor deflation in goods and services at times.
See J. Ahmad, Floating Exchange Rates and World Inflation (1984); A. J. Brown, World Inflation since 1950 (1985); T. S. Sargent, The Conquest of American Inflation (1999); R. J. Samuelson, The Great Inflation and Its Aftermath (2008).
The Columbia Electronic Encyclopedia, 6th ed. Copyright © 2012, Columbia University Press. All rights reserved.
More on inflation from Infoplease:
See more Encyclopedia articles on: Economics: Terms and Concepts