What is inflation?
Inflation is a means to measure the purchasing power of the currency we use by monitoring changes in the prices of goods and services we purchase. It is also defined as a continuous increase in the level of prices of goods and services in an economy over a certain period of time. Inflation generally leads to a decrease in the purchasing power of the local currency. You'll notice this when you find that the money you carry in your pocket will buy you less of a certain commodity than before, even though the money you currently have is more than before.
Inflation can also be defined by its causes, as it is an increase in the quantity of money leading to price hikes. However, the rate, speed, and nature of inflation can vary from one economic condition to another.
Central banks around the world try to keep inflation under control through specific measures and policies. Many of these banks often aim to keep the annual inflation rate between 2 to 3%. Inflation is usually measured by various indicators, with the Consumer Price Index being one of the most important.
To simplify, let's provide an illustrative example: if we have an inflation rate in a country of 3%, it means that what costs you $100 now will cost you $103 next year. However, it's not as straightforward as it seems.
While the concept of inflation may seem simple as illustrated in the previous example, it is actually more complex. This complexity arises because the prices of goods and services tend to grow but at vastly different rates, and sometimes they may even contract significantly.
How can we measure inflation?
1- Consumer Price Index (CPI):
On the economic agenda is the abbreviation of CPI
Its definition is the measure of the monthly change in prices for a specific basket of consumer goods, including food, clothing, and transportation, for example. When calculating the Consumer Price Index for any country, there is a very large list of consumer prices whose prices are calculated to arrive at this figure seen on the economic agenda. There is also a core Consumer Price Index (Core CPI), which is considered more accurate in reflecting price levels. It is calculated by excluding prices of food and energy.
2- Producer Price Index (PPI):
On the economic agenda, PPI stands for the Producer Price Index.
This index measures the average price change in a fixed basket of goods that are sold in markets by producers, unlike the Consumer Price Index, which measures goods demanded in markets by consumers. The Producer Price Index is one of the key tools for measuring inflation in the economy. It reflects price changes that occur in the production sector. However, it is considered less important and less capable than the Consumer Price Index in determining price levels. It is also preferred to exclude energy prices due to their volatility, which is called Core PPI.
There is a positive correlation between PPI and CPI, meaning that an increase in the Producer Price Index indicates that the Consumer Price Index will also increase. Therefore, it is expected that interest rates for the currency will rise in the short term, making the currency stronger against other currencies.
3- Retail Sales:
Retail Sales refer to the quantity of goods sold in retail stores (the retail sector), reflecting monthly changes in sales. This index reflects consumer spending. The figure derived from retail sales is the most indicative of changes in the value or purchasing power of money because it is related to goods and services that concern every individual in society, without exception. Analysts often exclude car sales because they are highly volatile and do not accurately represent the actual increase or decrease in consumer spending.
Practical Measurement of Inflation:
As mentioned earlier, inflation is measured by a set of economic indicators, including Consumer Price Index, Producer Price Index, Retail Sales, and some other less significant indicators. The US inflation calculator is available through this link to determine the purchasing power of the US dollar over time.
In this link, there is a calculator for the US inflation level from 1913 to 2024. For example, if you want to know what value equals $100 in the last 5 years from 2019 to the current year 2024, you can enter $100 in the box on the right side, choose the year 2020 in the top box, then choose the year 2024 in the last box, and then click Calculate. The amount equivalent to this year will be approximately $120, indicating an increase of about 20% over the last 5 years.
Types of inflation
The inflation rate and its speed and nature can vary from one economic situation to another. It can also be classified according to the factors causing it and the effects resulting from it. Here we will explain the differences between the various types of inflation and the most common ones.
1- Slow Inflation:
Slow inflation may be fixed or fluctuating. Inflation is considered slow if its rate ranges between 2% and 3%. Many economists believe that this rate at a minimum (around 2%) is good because it constitutes an incentive for producers to increase their production.
This inflation is the result of a moderate increase in demand or an increase in production costs.
Today, monetary authorities in the world are keen to make this level of 2% inflation a target for their inflation policies. In addition, slow, steady inflation that can be monitored is less dangerous than volatile inflation, which may turn into creeping or runaway inflation at times.
2- Creeping inflation
This type of inflation is characterized by a slow rise in prices over a long period of time at relatively moderate and stable rates. This type of inflation occurs when demand increases while supply or production is constant (stable), leading to a rise in prices that can rise naturally to 10% for example.
3- Stagnant inflation
This type means that inflation coincides with stagnation in the economy, such as unemployment and lack of investment, as the accompaniment of inflation and unemployment has become a new puzzle that preoccupies economists, meaning that inflation and unemployment exist together and form a new term called stagflation.
Stagnant inflation occurs when there is an increase in the price level with a gap in output and employment, and it usually indicates an inefficient economy.
4- Runaway or rapid inflation
Hyperinflation is characterized by its rapid development, and if economic policy is unable to limit its acceleration, it may turn into horrific inflation that may threaten the collapse of the monetary system, as money loses its basic functions (hyperinflation in Lebanon had reached a rate of 400% in 1987 and was almost to horrific inflation if the civil war had not ended and anti-inflation policies had not been followed since 1992). Rapid inflation, even if its rates were high, may not necessarily lead to the horrific inflation that Germany experienced after World War I in the years 1922-1923, when the government implemented Anti-inflationary policies. In one month of 1923, prices rose at a rate of approximately 30,000%.
Also in Hungary in 1946 inflation averaged 207% per day.
This horrific and severe inflation was also experienced by many Latin American countries during the seventies and eighties, as was the former Yugoslavia.
In late 2008, Zimbabwe witnessed inflation reaching 98% daily, until a trillion dollar bills ended up being issued as banknotes in circulation, until a 1,000 Zimbabwe dollar note became cheaper than a toilet paper.
5- Suppressed inflation
This type of inflation often appears in countries that adopt a command economy, where the state issues money without a cover of the dollar or gold for the purpose of public spending for the state, which leads to higher prices as a result of increased demand for supply due to the abundance of cash, so the state resorts to intervention in order to control Prices by setting quotas of goods and services for each individual, which leads to the emergence of the parallel market (black market).
Causes of inflation
Many things cause inflation, not just one reason. Here we will review the most important of these reasons:
1- Inflation resulting from increased expenditures
The main reason for this is the increase in wages. How can that be?!!
The rise in prices resulting from an increase in the costs of production elements, which is without a clear change in the demand for this product. The most important element that represents an increasing cost is the labor element and the desire of the workers to increase their income. Therefore, the state increases the salaries of its workers and employees without bearing this increase, but rather By raising the prices of this product in the markets even before raising workers’ salaries, the rate of increase of which is less than the rate of raising the price in the markets, and accordingly
Prices rise and citizens' purchasing power decreases as a result of the increase in prices more than the increase in salaries
So the increase in production expenses is mostly due to an increase in wage rates
2- Inflation resulting from increased demand
This type of inflation occurs when the demand for goods and services is greater than the supply in the markets, and therefore prices rise, so the state increases production and thus raises wages for workers, so purchasing power becomes higher, and thus demand increases, and so on.
That is, we are inside a vicious circle of increasing prices, but the increase in aggregate demand is not sufficient for prices to rise unless the supply of goods and their production are constant, which could be due to the government’s inability to expand production and insufficient stock to meet the new demand, or the deficit is real. In some sectors, and therefore also, the only way that can achieve a balance between supply and demand is by raising prices.
3- Inflation resulting from economic distortions
Where prices can rise and cannot fall despite the decline in demand, the reason for this is the presence of corruption, monopoly, or greed of merchants.
4- Increased siege
It arises when a group of countries practices an economic blockade against other countries, as happened in the United States’ blockade of Iraq and Cuba, where prices rise as a result of the lack of import and export.
5- Inflation arising from printing money
The question here is whether if we print money we will become rich??!!!!!!
of course not
To illustrate this, we assume that the Egyptian government printed money, and this money was distributed to each citizen, about 10 thousand pounds per citizen.
What will you do with this money?
Some will save it, some will pay off debts, but dear ones will spend this money
Whoever buys basic or non-essential goods, and let us assume that you are going to buy a phone from a local company, after I buy this phone, I will not be the only one who will buy it from this same company, but rather a good number of people will think about buying this phone.
Will they keep the price the same or not? Of course not, they will raise its price so that they can meet the increasing demands.
Therefore, this amount of 10 thousand pounds will decrease in value as a result of the increase in the price of the phone, and here inflation occurs, meaning that we have money, but we cannot meet our requirements due to the decrease in the value of our money.
And let us assume another hypothesis that this mobile phone company has decided to meet the needs of all the people who want to buy their product, and therefore it will increase its production to meet all these needs, but in order for it to increase its production, it must increase the working hours of the workers. It can also employ new workers, and thus the number of workers that will increase They will receive an increase in their working hours, along with new salaries for new workers, which will lead to an increase in the cost of the commodity, and thus prices will rise and our purchasing power will decrease.
With more money available to the company’s workers as a result of working extra hours, they will be able to meet their personal needs by purchasing other products, which leads to an increase in the price of these products to meet the increasing demand for them, and thus we enter into the same circle again.
Which is mainly caused by printing more money without it being backed by gold or stable foreign currencies and commodities.
Inflation risk
Inflation has economic and social effects that are divided into two types: -
1- Imaginary risks
It is the gradual erosion of the real standard of living because we have a lot of money but cannot meet our living requirements.
The reason is that the measure of luxury is not measured by the amount of money we have, but rather by our purchasing power.
The main losers from inflation are those with fixed incomes, including employees, workers, pensioners, and of course the unemployed, whose situation is getting worse and worse.
2- Real risks
1- Inflation weakens individuals’ confidence in the local currency and lacks the incentive to save, and here
The preference for goods over the preference for money increases, so individuals tend to spend money on present consumption
Their tendency to save decreases, and their remaining money tends to be converted into gold and stable foreign currencies or to purchase goods and real estate.
2- Inflation leads to a deficit in the balance of payments due to the increase in demand for imports in foreign currency and the decrease in the volume of exports. The inflationary increase in money results in an increase in demand for local goods as well as those imported from abroad, and thus the import will withdraw the foreign currency present in the country, especially in the case of facilitations from the state for imports. .
However, if the state places restrictions on imports, the demand for local goods increases as a result of the difficulty of importing, and thus prices rise as a result of the increased demand as well.
3- Inflation leads to directing capital to produce goods whose prices constantly rise, which are usually luxury goods that are demanded by those with high incomes.
4- Inflation leads some people to resort to borrowing during periods of inflation, because the loan will be repaid with less valuable money, and thus projects seek to borrow, but banks are conservative for the same reasons.
5- Inflation leads to confusion in the implementation of development projects due to the impossibility of determining the costs of constructing projects definitively, due to their constantly rising components during the period of project implementation, which leads to the inability of sectors to obtain the resources necessary to complete their projects, and thus national planning becomes unaffordable. .
6- Inflation leads to social injustice that strongly affects those with fixed incomes, such as pensioners and bondholders, whose cash incomes lag behind the rise in prices, while those with variable incomes, such as merchants and producers, benefit.
7- Inflation leads to a threat to the value of monetary assets, and the threat of erosion of monetary assets is linked to rampant and horrific inflation, and these monetary assets such as savings accounts, insurance policies, government debt bonds, and all of these assets are eroded as a result of inflation.
8- Inflation leads to weak growth due to not using full production capacity due to the fear of turning inflation into unacceptable or horrific inflation. Therefore, governments try to activate intentionally imposed unemployment in order to avoid worsening inflation in the hope of reducing its severity.
Since the risks of unemployment are borne by a minority in society, while inflation is felt by everyone, governments are willing to accept an increase in unemployment rates in exchange for a reduction in inflation rates, but they are not willing to accept more inflation in exchange for a reduction in unemployment.
9- Inflation leads to inequality in the distribution of income and wealth, and leads to a wave of tension and social discontent, which may cause a threat to the social and political stability necessary to advance the economic development of any country.
10- Inflation distorts economic decisions, as inflation can lead to making ineffective economic decisions, such as preferring future spending at the expense of current spending.
* Inflation represents a warning that will accelerate until money becomes useless and a comprehensive economic and social collapse occurs, even if terrible inflations are rare and are all the result of disasters or wars. However, the specter of the possibility of this happening is very disturbing, and it may be the reason for the feeling of inflation at all times. It is a danger in the future.
How to combat inflation
Governments follow some measures to reduce inflation and reach the rates targeted by central banks. In most major economies, the target inflation rate is approximately 2% to 3%.
This is done by disrupting the role of money in economic activity, absorbing the increase in the cash balance and reducing production, then freezing growth rates until prices return to normal in what is known as a tightening (deflationary) policy, and inflation is confronted with several measures: -
1- Reducing government spending means that the government reduces its total spending in society, so that there is less liquidity in the hands of individuals, banks, and institutions, instead of printing money that causes inflation.
2- Imposing taxes of all kinds, such as corporate taxes and indirect customs duties on local or imported goods. The effect of this tax falls on individuals, as the government withdraws part of the money from them, and thus the individuals’ demand for goods and services decreases, and consequently the total demand decreases.
3- Raising interest rates on the currency so that liquidity is absorbed by raising interest rates to encourage citizens to put their money in banks.
4- Governments direct control over prices by setting a maximum and minimum limit and using the card system to distribute necessary goods.
5- Stimulating productivity through investment in infrastructure, education, and technology to increase productivity and the ability to meet demand without an increase in prices, while producing some necessary goods at the expense of some luxury goods and luxury goods.
6- Wage control.
7- Reducing restrictions on imports of basic goods.
8- Tightening credit conditions for commercial banks, such as increasing mandatory reserve requirements, which reduces their ability to provide loans and thus reduces spending.
Here we have finished this thorny topic that occupies the minds of many
Especially in our Arab world, especially Egypt, where inflation rates have risen to very high levels, and we hope that it will be controlled in the near future.
