Inflation refers to the phenomenon where the overall price levels of goods and services in an economy continue to rise. Inflation means that the same amount of money will buy fewer goods and services in the future than it can today, or in other words, the purchasing power of money decreases. Simply put, inflation reflects rising prices.
Causes of Inflation
Demand-pull inflation: When demand in the economy exceeds supply, prices rise. For example, if consumers' demand for a particular product increases but production is insufficient or supply chains are constrained, prices will rise.
Cost-push inflation: When production costs increase, businesses pass these costs on to consumers, causing prices of goods and services to rise. For instance, if raw materials or labor costs go up, prices will follow.
Increase in money supply: When a country's central bank prints a large amount of money, the quantity of money in circulation increases. If the money supply grows faster than the real economic growth, prices will be pushed higher.
Effects of Inflation
Impact on consumers: Inflation raises prices, weakening the purchasing power of money. Wages may not keep pace with the rising prices, which can negatively affect people's standard of living.
Impact on the economy: Moderate inflation can help stimulate consumption and investment, as people may prefer to spend or invest now, expecting prices to rise in the future. However, excessive inflation can lead to economic instability and even hyperinflation, harming economic growth.
Dangers of hyperinflation
Hyperinflation refers to an economic phenomenon where prices rise at an extremely rapid rate, and the currency rapidly depreciates. It is usually defined as a situation where the monthly inflation rate exceeds 50%.
Currency Collapse and Loss of Purchasing Power
Hyperinflation leads to a dramatic decline in the purchasing power of money. As the value of the currency drops rapidly, people need more and more money to purchase the same goods and services. As the currency loses its value, people lose confidence in it and turn to more stable foreign currencies or tangible assets to store their wealth. In some extreme cases of hyperinflation, prices can double within hours, making daily life unsustainable.
Erosion of Savings and Wealth
As the currency depreciates quickly, personal and corporate savings rapidly lose value, especially savings denominated in the local currency. This leads to the evaporation of wealth for the middle class and savers, causing a sharp decline in living standards. To avoid losses, people rush to convert cash into tangible assets or foreign currencies, further exacerbating the vicious cycle of currency depreciation.
Collapse of Economic Activity
Hyperinflation causes the basic functions of the market economy to break down, affecting both consumer and business decisions, and can even lead to the collapse of the entire economic system. When prices change too quickly, businesses cannot accurately predict costs, and consumers cannot judge fair prices, leading to imbalances between supply and demand and market chaos.
Triggering Political Crises
Due to the far-reaching impacts of hyperinflation on society and the economy, governments often struggle to maintain legitimacy, leading to regime changes, political crises, or even authoritarian rule. During periods of hyperinflation, traditional economic control measures often fail, causing the government to lose its grip on the economy. Social unrest and political turmoil can lead to the rise of extremist or authoritarian regimes, further disrupting societal order.
How Governments Control Inflation
Monetary Policy
Monetary policy is implemented by central banks (such as the People's Bank of China, the Federal Reserve, etc.) to influence economic activity by controlling the money supply and interest rates, with the aim of controlling inflation.
Raising interest rates: Central banks can raise the benchmark interest rate, leading to an increase in borrowing costs for banks. This, in turn, suppresses consumer and business borrowing and spending. Higher borrowing costs reduce the money supply in the market and lower demand, helping to curb rising prices.
Reducing money supply: Central banks can absorb excess liquidity by selling government bonds, reducing the amount of money circulating in the market, and thereby controlling inflation.
Increasing reserve requirements: Central banks can require commercial banks to raise their reserve ratios, reducing the amount of money available for lending. This decreases the money supply and helps to control inflation.
Fiscal Policy
Fiscal policy is implemented by the government and primarily affects economic activity through adjustments to taxation and government spending.
Reducing government spending: The government can reduce spending on infrastructure, public services, and other areas to lower demand in the economy, thereby alleviating inflationary pressure.
Raise taxes: By increasing personal income, corporate or consumption taxes, governments can reduce disposable income in the marketplace, lowering consumer demand and investment, and thus reducing inflationary pressures.
Control of inflation is an important goal of central banks, moderate inflation contributes to the development of the economy, but hyperinflation will greatly undermine the economy and social stability, central banks through monetary policy and fiscal policy and a number of macro-control measures to control inflation and achieve economic development.
