Inflation is a threat that is creeping up on your wallet

Do you know why your grandmother constantly repeats that everything was much cheaper in the past? Behind this sad nostalgia lies a real economic phenomenon — inflation is the process by which the purchasing power of money gradually decreases, and prices for goods and services rise. This phenomenon affects each of us, influencing our savings, salaries, and future plans. To understand how inflation works and why it occurs, we need to look beneath the surface of the economy.

How Inflation Begins: Key Mechanisms

Inflation is a consequence of an imbalance between supply and demand. At a fundamental level, there are two key scenarios. The first is when the money supply in circulation grows faster than the actual production of goods. A historical example: when European explorers in the 15th century brought large amounts of gold and silver from the New World to Europe, a sharp increase in the money supply led to rising prices across the economy.

The second mechanism works differently. If demand for a specific good suddenly increases and producers cannot quickly increase output, prices start to rise. This localized phenomenon can spread further, causing a general increase in prices for almost all goods and services in the economy.

Economists identify three main types of inflation, well described by the so-called triangular model proposed by scholar Robert Gordon.

Demand-Pull Inflation: When Everyone Wants More

This type of inflation is the most common and occurs when people want to buy more than the market can supply. Imagine a city bakery that produces a thousand buns a week and sells exactly that amount. The economy improves, people have more money, and demand for buns skyrockets to two thousand per week. The baker cannot instantly increase production — ovens and staff are operating at capacity.

In such a situation, it’s quite logical to raise the price. Some buyers will agree to pay more because buns have become scarce. If demand simultaneously increases for milk, butter, meat, and other goods, the economy enters a demand-pull inflation period. Everyone wants more, but everything is not enough, and prices creep upward.

Cost-Push Inflation: Rising Costs, Rising Prices

It can also happen differently. The baker expanded production to four thousand buns a week — demand is fully satisfied, everything is calm. But suddenly, there is a wheat harvest failure. Raw material prices increase, and the baker has to raise prices on his goods, even though demand remains the same. This is cost-push inflation — prices rise not out of greed, but due to increased production costs.

At the macroeconomic level, such inflation is caused by: shortages of critical resources (oil, metals), tax increases on goods, weakening of the national currency (imported goods become more expensive), or wage growth not supported by productivity increases.

Built-In Inflation: Echoes of the Past

This is the most insidious type. If the first two forms of inflation persist for a long time, inflation expectations form in the economy. Workers remember that prices have risen and demand higher wages to protect their incomes. Companies, seeing this, raise prices on goods. Workers see the price increases and again demand more money. A self-reinforcing cycle emerges, which is very difficult to stop. Built-in inflation occurs when the history of economic shocks begins to work against stability.

How Governments Fight Inflation

Uncontrolled inflation destroys the economy, so central banks and governments actively counteract this phenomenon. The arsenal of tools includes monetary and fiscal policies.

Raising Interest Rates — The Most Direct Method

Central banks, such as the Federal Reserve in the USA, raise interest rates to make borrowing more expensive. When money is costly to borrow, people spend less, demand falls, and prices stop rising. However, this method has a side effect — growth may slow down because companies and households become more cautious with investments.

Monetary Operations

The Federal Reserve can change the money supply itself. Quantitative easing (QE) — buying assets to add money into the economy. Paradoxically, this can boost inflation and is used in reverse situations. The opposite policy — quantitative tightening (QT) — reduces the money supply and helps curb inflation.

Fiscal Policy: Taxes and Spending

The government can change taxation. Raising income taxes reduces people’s disposable income, leading to less spending and lower demand. This works, but politically it’s risky — taxes are always unpopular. Reducing government spending has a similar effect.

How Inflation Is Measured

To make informed decisions, you need to know the scale of the problem. Most countries use the Consumer Price Index (CPI). It tracks prices for a basket of typical goods and services purchased by ordinary households — food, transportation, housing, entertainment.

The U.S. Bureau of Labor Statistics (BLS) collects data on prices nationwide monthly. If the CPI in the base year is 100 and reaches 110 after two years, it means prices have increased by 10%. Simple math, but a powerful tool for monitoring economic health.

A small inflation rate of 2-3% annually is considered normal and even beneficial. It’s a natural phenomenon in a fiat currency system that encourages people not to hoard cash but to invest or spend.

Two Sides of the Same Coin: Pros and Cons

It may seem that inflation is purely evil, but reality is more complex.

Benefits of Inflation

Stimulus for spending and investment. Knowing that money will be worth less tomorrow, people prefer to spend it today. This stimulates consumption, companies expand production, and hire more people. Investments also become more attractive — better to buy an office or equipment than hold cash.

Increased profitability for companies. Firms can raise prices above the growth of costs and earn additional profit. This helps them invest in development.

Better than deflation. The opposite phenomenon — deflation, when prices fall — is much worse. People delay purchases expecting even lower prices, demand drops, unemployment rises, and the economy stagnates.

Drawbacks of Inflation

Erosion of savings. If you set aside 100,000 rubles for the future, after ten years of high inflation, they will be worth much less. Pensioners suffer especially because their incomes do not grow with prices.

Hyperinflation — an economic nightmare. When inflation spirals out of control and prices increase more than 50% per month, it’s hyperinflation. Money literally loses its value before your eyes. What cost $10 a month ago now costs $15. Currency ceases to serve as a store of value, and people switch to foreign currencies or goods.

Uncertainty paralyzes the economy. When inflation is high and unpredictable, both companies and households lose confidence. They cut back on investments, freeze hiring, and economic growth slows down.

Government intervention undermines free markets. Some economists criticize government attempts to “print money” and artificially control inflation, seeing it as a violation of natural market laws.

The Main Conclusion

Inflation is an integral part of the modern economy. It is not the number one enemy — a small amount of inflation is even beneficial. But if it gets out of control, the consequences can be catastrophic. The key to prosperity is flexible monetary and fiscal policy, allowing governments to respond to changes while keeping inflation within healthy limits. Successful inflation management is a balance between stimulating economic growth and protecting the real value of citizens’ money.