# inflation

Simplified illustration of the monetary policy transmission mechanism from the key interest rate set by the central bank to the prices.
Annual rates of change in prices in Germany since 1965
Development of nominal and real wages in Germany
Change in nominal and real wages in Germany
Development of the consumer price indices in different countries
Origin of the equilibrium price (Note: The ceteris paribus condition is a prerequisite for this consideration to be valid .)

Inflation (from the Latin inflatio "inflation", "swelling") describes in economics a general and sustained increase in the price level of goods and services ( inflation ), synonymous with a decrease in the purchasing power of money .

For many central banks , maintaining price level stability is a priority, although slight inflation is expressly desired to distinguish it from deflation to the contrary . The European Central Bank , for example, aims to keep the inflation rate below but close to 2% in the medium term through its monetary policy .

## Measurement

International price level development
year Austria Germany Japan Switzerland United States
2005    588 411 652 427 736
2003    563 397 654 419 694
2000    532 380 667 410 649
1998    517 372 673 400 615
1995    496 357 657 395 575
1993    471 342 653 385 545
1990    423 300 614 338 493
1985    380 280 574 299 406
1980    299 232 501 242 311
1975    232 190 364 216 203
1970    163 141 212 149 146
1965    139 126 163 126 119
1960    114 110 121 107 112
1955    102 100 113 101 101
1952    100 100 100 100 100
Source: IMF's International Financial Statistics

Inflation is measured either through annual changes in the prices of goods and services in certain baskets or through the GDP deflator , which shows the changes in the prices of all goods in an economy . Inflation is an object of knowledge in economics, especially macroeconomics . The consumer price index is most often used to measure inflation . The index is calculated using a basket of goods that is set in a certain year ( base year ) as representative of an average household.

Since July 2002, the Federal Statistical Office has been using the so-called “ hedonic price adjustment” to calculate inflation for some product groups. Changes in quality should be taken into account in the price measurement. This method is used, for example, for IT products that are subject to rapid change and that cannot be observed in identical form over a longer period of time. The introduction of hedonic price adjustment led to significantly lower rates of change in the affected sub-indices for IT goods due to the strong technical progress and comparatively stable prices.

In addition to this purely statistical method has the economics of the cost of living index (COLI = = cost of living index ) established. It measures the expenditure that economic agents have to make in order to achieve a certain level of benefit .

While the inflation described in this way can be more accurately referred to as consumer price inflation, it is called asset price inflation when the prices of assets such as stocks and real estate rise.

### Importance of the shopping cart for measuring inflation

On the basis of this basket of goods and the base year determined with it, the cost of living and from this the percentage increase compared to the previous year or the previous year are determined for each year. For each month determined in Germany by the Federal Statistical Office, in Austria , the Statistics Austria and in Switzerland , the Swiss Federal Statistical Office , the price increases and publish it.

Problems in measuring these numbers result mainly from the fact that the greater the distance to the base year, the less representative the basket of goods is, as consumer behavior is constantly changing. For example, innovations in the shopping cart are only partially taken into account. In addition, it does not take into account the fact that more expensive products are quickly replaced by similar goods in consumer behavior (see also price elasticity of demand ).

The value is also aggregated across all income groups, so it does not say anything about the extent to which individual income groups are affected.

### Core rate

The core rate of inflation excludes the prices for food and the energy sector from the calculation, as these are subject to greater fluctuations, the causes of which cannot be found within the economy under consideration.

## Perceived inflation

Consumers perceive the level of inflation differently. One reason for the discrepancies between the “ perceived inflation” and the measured inflation is the fact that the shopping basket, which is used to measure inflation, contains both daily necessities (such as groceries) and durable consumer goods (such as cars ) and the products are in The selection or weighting does not match each individual consumer or each individual consumer group. The perception of price changes is higher for everyday goods than that for durable consumer goods. This means that the perceived inflation is higher than the measured one when the prices for everyday goods rise faster than the prices of durable consumer goods (and vice versa). Price increases of mostly automatically debited payments for rent, insurance, energy and water are also perceived less than for other goods.

Example price for a liter of petrol : In 1985 the price for a liter of premium petrol was 0.73 euros, adjusted for inflation this corresponds to around 1.31 euros in 2018. In 1986 the price fell to around 0.55 euros, adjusted for inflation this corresponds to around 0.97 euros 2018. The price for a liter of premium gasoline was 1.20 euros adjusted for inflation at the beginning of 2016, at the beginning of 2018 at 1.37 euros and at the end of August 2018 at around 1.49 euros.

Example for a liter of cow's milk : The milk price in 1974 was 0.49 euros, adjusted for inflation, this corresponds to around 1.40 euros in 2018. The liter of cow's milk cost 0.69 euros in the discounter in August 2018 .

Example VW Beetle / VW Golf : Adjusted for inflation, the price of a VW Beetle was probably always in the order of magnitude of the entry-level price that would have to be paid for a VW Golf in 2018, but with the Golf the buyer is already much more comfortable in the entry-level class (space, Engine power, occupant protection, comfort equipment such as air conditioning, etc.). Golf-class vehicles that clearly outperform a VW Beetle are offered by manufacturers such as Dacia for around half. This price segment also includes small cars from VW , which outbid a VW Beetle in all areas with the exception of size.

Whether something actually becomes more expensive essentially depends on whether the wage increases offset inflation (see real wages ). But it is also a question of purchasing power that is changing due to social mobility .

The phenomenon of “perceived inflation” was widely discussed , especially after the introduction of the euro . In 2002 there was a divergence in some countries of the European Community between the inflation rates, as they were perceived by the population according to surveys, and those as determined by the statistical offices, in Germany the Federal Statistical Office. For this reason, Hans Wolfgang Brachinger calculated the index of perceived inflation for Germany in a joint project with the Federal Statistical Office . It could be shown that the perceived inflation (measured with the help of the perceived inflation index) was significantly higher than the official inflation rate when the euro was introduced. This is due to the fact that everyday expenses for food, gasoline or transport had a higher price increase than more expensive, superior goods such as computers, cars or package tours.

## Effects

Price index of private consumption in Germany , the USA , Japan and other countries

### Internal value and purchasing power

A distinction must be made between inflation and purchasing power. If inflation makes itself felt equally in wages and prices , real wages , real prices and consumer purchasing power remain unchanged. In reality , however, inflation often has an impact on purchasing power. If prices rise faster than wages, then real wages fall and consumer purchasing power falls. If wages rise faster than prices, then real wages and purchasing power rise.

With contracts concluded before inflation , the economic equilibrium shifts. In this way, the debtor is generally better off while the creditor's position deteriorates. This applies, for example, to rents, maintenance payments, pension and retirement entitlements and fee claims based on the statutorily regulated fee structure such as that of lawyers and doctors . In the German inflation from 1914 to 1923, for example, the owners of real estate were in fact fully discharged, while the real estate roughly retained its value. The legislature tried to skim off these inflationary gains through the house interest tax .

One of the major short-term beneficiaries of inflation is the state as a major institutional debtor . The real value of his debt is falling significantly due to inflation. The cold progression also increases real tax revenues. The biggest losers are holders of financial assets and fixed income securities such as government or corporate bonds .

With severe inflation, the speed of circulation of money increases , because since money is constantly being devalued, nobody wants to keep it for long.

If not enough valuable real capital can be produced, an attempt is made to invest value in foreign exchange . The devaluation of the money is accelerated.

If the state tries to regulate free price formation , inflation will be concealed or dammed up instead of openly . It manifests itself, among other things, in queues of buyers or in the formation of a black market whose price increases do not appear in any statistics.

### External value of the currency

In the case of flexible exchange rates , an adjustment is made by devaluing the exchange rate of the domestic currency against foreign currencies. This prevents unwanted foreign trade effects (see section "Exchange rate and foreign trade" in the article "Foreign trade theory" ).

There is no automatic correction for fixed exchange rates. If inflation is higher than in other countries, the cheaper imports , the exports become more expensive. This leads to trade deficits .

### Expressions

German inflation money from 1923 (aluminum, diameter 27 mm)

Depending on the strength and speed of price increases, a distinction is made between creeping inflation, trotting inflation, galloping inflation and hyperinflation .

Inflation can be divided into phases: accelerated phase (rising, accelerated) - stabilized (constant) phase - decelerated (decreasing) phase. The decelerated phase is also known as disinflation .

The term "inflation" originally referred to the early 1920s inflations , which are now considered severe or hyperinflation. Today it is used in isolation from the real rate of increase in price levels in a country.

Slight inflation (up to around 5% depreciation per year) has a demand-promoting effect, because people want to spend or invest their money. Of course, they still demand a liquidity premium for investments , which means that the returns must be well above the inflation rate.

In the event of severe inflation (from around 5% loss in value per year), money as a medium of exchange loses its value more quickly than other goods (e.g. real estate, shares, physical capital in general) and therefore loses its function as a yardstick and store of value ; instead, a substitute currency is used, for example Cigarettes in Germany after World War II , the US dollar in Turkey (earlier) or Argentina . There is a flight to stable property and capital . On the capital markets , the supply of capital is decreasing, as the providers expect a depletion of values ​​due to inflation and the interest on capital rises. For the same reason, long-term loans are rarely offered, especially not with a fixed interest rate . There is no longer any planning security for borrowers either. Investments that were barely worthwhile up to now become unprofitable due to rising interest rates ; Companies whose returns are no longer sufficient get over-indebted.

Particularly severe inflations with monthly losses of more than 50% are also known as hyperinflation . Hyperinflation has come to a standstill several times in history because even the real value of the paper used to print the banknotes was higher than the value of a banknote. Often there is currency reform after hyperinflation .

Price for a breakfast egg around 1923
date Purchase price
0June 6, 1912 7 pfennigs
0August 6, 1923 923 paper marks
August 27, 1923 177,500 paper marks
September 17, 1923 2.1 million paper marks
October 15, 1923 227 million paper marks
0November 5, 1923 22.7 billion paper marks
November 15, 1923 320 billion paper marks

History of severe inflation included:

## Causes and reasons

### Monetary inflation theories

#### Quantity theory

The historically oldest explanation for inflation is offered by the quantity equation :

${\ displaystyle Y \ times P = M \ times U}$.

It is

• ${\ displaystyle M:}$ Money supply
• ${\ displaystyle U:}$ Velocity of money
• ${\ displaystyle P:}$ Price level
• ${\ displaystyle Y:}$ Real production

At the rearranged equation

${\ displaystyle P = {\ frac {M \ cdot U} {Y}}}$

or the representation with rates of change

${\ displaystyle {\ widehat {P}} = {\ widehat {M}} + {\ widehat {U}} - {\ widehat {Y}}}$

one can see that the price level always rises when (given the constancy of the other two sizes)

• the money supply increases ( money creation ),${\ displaystyle M}$
• the speed of circulation of money increases ( empirical studies show that the speed of circulation remains approximately constant in the long term),${\ displaystyle U}$
• real production (trade volume) falls.${\ displaystyle Y}$

If one considers all four quantities at the same time, then, according to the quantity equation, inflation ( ) occurs when the money supply growth ( ) is greater than the difference between the change in the trading volume and the change in the velocity of circulation ( ). ${\ displaystyle {\ widehat {P}}> 0}$${\ displaystyle {\ widehat {M}}}$${\ displaystyle {\ widehat {Y}} - {\ widehat {U}}}$

The quantity theory is very well documented empirically. These studies show that inflation occurs when the central bank expands the money supply too much. Conversely, this means that inflation can be prevented through a restrictive monetary policy . See also quantity theory .

#### Austrian School / Vienna School

Ludwig von Mises , a representative of the Austrian School , understood inflation to mean the expansion (Latin inflare ) of the uncovered money supply . Cyclical and uncontrolled monetary growth would create credits ex nihilo with artificially low interest rates. Inflation and credit expansion would distort the entire price system, the price would lose its function of informing about scarcity, and unproductive modes of production would be artificially kept alive.

Newly created money reaches market participants from the central and commercial banks , who use this new money to demand goods. This additional demand is reflected in rising prices. The cause of inflation is to be found in the creation of uncovered money as well as in legally privileged institutions of banking and finance ( compulsory acceptance of legal tender , central banking , partial reserve banks , currency monopoly , etc.). From this point of view, it can also be seen that inflation is not reflected equally in all prices, but is influenced by Cantillon effects .

### Non-monetary inflation theories

A basic distinction is made here between demand inflation and supply pressure inflation.

#### Demand side

If it comes to Nachfragesoginflation ( English demand-pull inflation ), are to seek the causes, as can be seen from the Word on the demand side.

In this case, the demand for goods rises so quickly that the supply side cannot react by increasing the quantity of supply and instead the prices rise according to the laws of the market . If this affects all goods, however, ceteris paribus, an aggregate price increase is not possible. If there is monetary support, inflation occurs. In the short term, this support can be provided by increasing the speed of circulation of the money . In the longer term, however, inflation can only exist if it is supported by a corresponding expansion of the money supply.

A distinction is also made between “home-made” and “imported” demand inflation , depending on whether the demand comes from home or abroad.

#### On the supply side

On the other hand, is offering push inflation (:; "cost inflation" and English cost-push inflation ), whose origins in the production costs are to be sought. These are primarily increases in personnel costs / ancillary wage costs ( English wage-push inflation ), energy costs or interest rate increases . Cost inflation only appears as an increase in the price level, however, when the more expensive goods also find buyers on the market at the higher prices required and there is no substitution from other markets ( seller's market ). This type of inflation can only exist in the long term if the money supply expands accordingly . " Cost-push inflation " occurs when a company has higher production costs, for example due to higher raw material prices ("imported" inflation) or higher wages, taxes, etc. ("homemade" inflation). “Profit push inflation”, on the other hand, is caused by the fact that a company wants to achieve higher profits .

#### Keynesian explanation

One of the basic tenets of Keynesianism is the negative dependence between inflation and unemployment . This assumption was based on empirical studies on the basis of historical data, which associated falling unemployment with a higher price level ( Phillips curve ). Theoretically, this principle was explained by the fact that with falling unemployment, national income rises and, as a result, the demand for consumer goods rises faster than production capacity can be created. In addition, at full capacity the prices rise and the unions can enforce higher wage demands at lower unemployment, which affects the prices (see also rate of change in the basic wage bill ). Contrary to this theory, stagflation occurred in the 1970s (high level of unemployment and high inflation rates). The Phillips curve was thus refuted insofar as it only applies if external influences (the 1970s were characterized by rising raw material prices) are kept stable and if production capacities are underutilized, which is particularly true in deflation .

If an economy exhausts its production possibilities to the full - one speaks in this context of the production possibility curve (PMK), synonym transformation curve - an increase in demand in Keynesianism leads to a price increase. The companies cannot compensate for the increased demand for products, so these products simply become more expensive (see demand-suction-inflation above). It is questionable whether bottlenecks will not occur in individual branches of the economy before a general full utilization of capacities is reached , so that prices begin to climb before full employment and generally full utilization of capacities has been reached. In the 1970s, the construction industry, as a particular beneficiary of Keynesian economic stimulus programs, was suspected of only reaping higher government demand in the form of higher prices (instead of investing more) - a case of moral hazard .

#### Other causes / reasons

Tax increases, state- administered price increases and wage increases can lead to a higher inflation rate regardless of the economic situation.

Another important term is imported inflation ; This means the transfer of inflation abroad to the home country. An economy is well hedged against imported inflation with flexible exchange rates , but with fixed exchange rates an economy cannot hedge itself against the import of inflation.

#### Production cost theory of money

Inflation, wallpapering with banknotes during hyperinflation is cheaper than with ordinary wallpaper

The classical economists like Adam Smith , David Ricardo up to Karl Marx advocated a production cost theory of money. For them the value of money and thus prices were determined by the doctrine of labor value . As Adam Smith put it: “The relationship between the value of gold and silver and that of any other goods depends ... on the relationship between the amount of labor required to obtain a certain amount of gold and silver, and the amount of labor which is necessary to bring a certain amount of some other kind onto the market. ”According to the labor value theory, commodity prices could only rise permanently if the labor productivity in gold or silver production could be increased more rapidly than that in production of the other goods.

According to the cost of production theory of money (or according to the labor theory of value), the large gold and silver imports from South America after the discovery of America did not lead to inflation in Europe because the large amount of gold "chased" a comparatively small amount of goods - that is what quantity theory says of money - but because suddenly less labor was required to extract a certain amount of gold or silver. The expansion of the money supply (the amount of gold and silver in circulation) was only a symptom of the suddenly lower labor value of the precious metals . The classics assumed that to handle the goods of an economy, which had a certain value overall, a total amount of gold of a certain value was required, depending on the speed of circulation of the gold coins . The speed of circulation was assumed to be stable. If the value of the individual gold coins fell due to the increase in labor productivity in gold mining, more gold coins were required to compensate for the money in circulation. The increase in the money supply was therefore only a symptom of the decrease in the value of the individual gold coin.

If more gold was put into circulation than needed for the handling of goods, this did not lead to price increases, but the excess gold was hoarded as a store of value. The economic subjects did not want to exchange gold for goods for less than its value, so the assumption of the classics.

It was different with paper money . No other laws applied to paper money than to gold coins, as long as the state or banks only issued paper money in such quantities that it could be exchanged for gold at a certain ratio at any time. But during the coalition wars, for example, a great deal of gold flowed abroad from Great Britain or was hoarded. Finally, the obligation to redeem gold for paper banknotes was lifted by the English state. After a while there were two prizes. The stable prices of goods are expressed in gold and the rising prices of goods are expressed in paper money.

Marx presented the situation as follows: As long as the amount of gold required for the handling of goods is replaced by paper money, gold and the paper money it represents are worth the same amount. If, however, in times of need the banks increase the circulation of paper money over the necessary amount of gold, then the prices in paper money will rise to the same extent. So while too much gold does not raise prices but is hoarded as a store of value, economic agents do not trust paper money to have this ability to store value, it is spent. But then too many banknotes “hunt” too few goods. The prices in terms of paper money are increasing. To this extent, the quantity theory of money applies to paper money.

## control

Graphic representation of global inflation rates (2019)

### State price regulation

One way to stop inflation is to tie prices and salaries with the state . An attempt to do so failed in the 1970s in the USA under President Richard Nixon , as inflation, as mentioned above, sought other paths, for example black markets. Many scholars consider price fixing to be pointless, even harmful to an economy and contrary to the principles of a market economy . An early attempt to keep prices from climbing is the maximum price edict of the Roman emperor Diocletian .

### monetarism

Long-term interest rate minus the GDP growth rate

Monetarists try to use the money supply to control inflation. A reduction in the amount of money in circulation (also known as M1 for short in Germany) would mean, for example, that the same number of products would have to be purchased with less money available.

### New Keynesianism

New Keynesians recommend interest rate control .

### European Central Bank

Today the European Central Bank pursues a monetary policy that combines interest rate control and money supply control.

### Austrian school

For the representatives of the heterodox Austrian school , the rise in the general price level is a consequence of inflation. The cause is the expansion (“inflation”) of the uncovered money supply by the central and commercial banks. The consequences of inflation can be avoided if the causes themselves are not favored politically. The favorable and avoidable causes include, in particular, the legal protection and the legal privileging of those financial institutions that produce "uncovered" fiat money .

## Differentiation of inflation from other phenomena

In the general sense and political parlance, various phenomena are associated or equated with inflation that may not be inflation.

### Cash holdings inflation

Cash-holding inflation describes a condition in which economic agents hoard more money than they actually want. According to economic theory, this situation does not occur in free markets, since the higher money stocks must lead to inflation. However, if the prices are (state) administered and the price level is measured using the administered prices, there is no inflation. Alternatively, however, inflation can be measured on non-administered markets (black market). Whether there is inflation is therefore a question of recognizing a definition authority . The objection to this thesis is that hoarded money stocks do not per se represent a money supply. Only that part of the money supply that economic agents plan to exchange for goods and services in the period under consideration constitutes an offer of money.

### External price shock

This expression was often used during the so-called oil crises . The rise in the price of a good does not necessarily lead to an increase in the price level. If the prices of other goods fall at the same time, the price level can remain constant. There is then no inflation. However, if the central bank supports the price increases, an effect analogous to the so-called cost pressure inflation can be triggered.

### Inflation tax

There was and was no inflation tax. Inflation tax is a catchphrase that pejoratively equates the economic disadvantage of inflation with the economic disadvantage of a tax . If the nominal income remains the same, the income tax remains unchanged, but the real income decreases due to inflation. At the same time, national debt is losing value in real terms (this only applies to bonds that are not indexed for inflation and unexpectedly high inflation, because if a certain inflation rate is expected, this inflation rate is factored into the interest rate demanded). In the event of unexpectedly high inflation, the state apologizes without paying anything of its own. This also applies to all other debtors. However, the state is the only one capable of effectively increasing inflation through its policies. As a final effect, the state can tax the taxpayer's inflation gains. After the hyperinflation of the 1920s, property owners were in fact discharged. The state taxed this inflation gain with house interest tax.

## literature

Wiktionary: Inflation  - explanations of meanings, word origins, synonyms, translations
Commons : Inflation  - collection of pictures, videos and audio files

## Individual evidence

1. European Central Bank: The Monetary Policy of the ECB (2011), p. 64, accessed on June 28, 2020.
2. Money and Monetary Policy , Chapter 6, The Eurosystem's Monetary Policy
3. Federal Statistical Office : earnings and labor costs - real wage index and nominal wage index , explanations p. 3, data p. 5, (PDF).
4. Federal Statistical Office : earnings and labor costs - real wage index and nominal wage index , explanations p. 3, data p. 5, (PDF).
5. Gabler Wirtschaftslexikon : Inflation , accessed on July 25, 2015.
6. European Central Bank : What is Inflation? , accessed September 4, 2012.
7. European Central Bank: The Monetary Policy of the ECB (2011), p. 9, accessed on June 28, 2020.
8. Federal Statistical Office: Hedonic Methods .
10. Werner Rothengatter, Axel Schaffer: Macro compact. Basics of Macroeconomics. 2nd, updated and expanded edition. Physica-Verlag, Heidelberg 2008, ISBN 978-3-7908-2007-2 , p. 141, online .
11. What was the average gasoline price in 1986? on Wissen.de.
12. What was the average gasoline price in 1986? on Wissen.de.
13. Average price for one liter of premium gasoline in Germany from August 2017 to August 2018 (in cents) on de.statista.com.
14. Federal Statistical Office: Project to measure “perceived inflation” .
15. ^
16. New Truths About Prices , Focus , No. 27, 2012.
17. Kristof Dascher: Economics. An introduction to building blocks. 2nd, expanded and updated edition. Oldenbourg, Munich 2013, ISBN 978-3-486-72103-4 , p. 40.
18. ^ Ferdinand Dyck, Martin Hesse, Alexander Jung: Kalte expropriation . In: Der Spiegel . No. 41 , 2012, p. 74–80 ( online - cover story).
19. Gerald Braunberger: Playing with inflation expectations , FAZ .net, December 21, 2012.
20. The checkered history of inflation in Austria (2017) on www.oenb.at.
21. Cato Institute: New Hyperinflation Index (HHIZ) Puts Zimbabwe Inflation at 2.79 trillion (10 18 ) percent , October 31, 2008.
22. Jörg Guido Hülsmann : The ethics of money production. Edition Sonderwege in Manuscriptum, Waltrop et al. 2007, ISBN 978-3-937801-19-3 .
23. ^ Demand-pull inflation in the English language Wikipedia
24. ^ Cost-push inflation in the English language Wikipedia
25. Helmut Wagner : Stability Policy. Theoretical foundations and institutional alternatives. 7th, revised and expanded edition. Oldenbourg, Munich et al. 2004, ISBN 3-486-20031-3 , p. 306 ff.
26. See in summary Hartwin Brandt : Renewed Thoughts on Diocletian's Price Edict. In: Alexander Demandt , Andreas Goltz , Heinrich Schlange-Schöningen (eds.): Diokletian and the tetrarchy. Aspects of a turning point (= Millennium Studies. 1). de Gruyter, Berlin et al. 2004, ISBN 3-11-018230-0 , pp. 47-55.
27. ^ Gabler Wirtschaftslexikon: Money overhang .
28. ^ Gabler Wirtschaftslexikon: Shock .