Getting to Know What Inflation is: Definition, Causes and Impacts

Infokekinian.com – When talking about the economy, of course we will definitely come across the word "inflation". Therefore, we will invite you to get to know what inflation is further.

In the economic field, inflation is a general process of increasing prices over time, which is related to market mechanisms and can be influenced by a number of factors.

Among other things, increased public consumption, excessive market liquidity that triggers consumption, or even speculation, including due to uneven distribution of products.

In other terms, inflation also refers to the continuous process of currency depreciation. To get to know what is inflation for more, let's see this article to the end.

What Is Inflation?

Instead of the rise and fall of the price level, inflation is the course of events. In other words, a high price level does not always mean inflation.

An indicator of the intensity of change, inflation is considered to exist when price increases occur continuously and have an impact on one another.

Inflation can also refer to an increase in the money supply, which is also blamed for rising prices. CPI and GDP Deflator are two of the most popular methods of determining the rate of inflation.

There are four categories of inflation, namely mild, moderate, severe and hyperinflation. When prices increase below 10% per year, they are considered mild inflation.

Between 10% and 30% annually is moderate inflation, while heavy inflation is between 30%-100% annually.

And hyperinflation is uncontrollable inflation, where price increases in a year are above 100%.

Causes of Inflation

The possibility of inflation is influenced by several factors. Inflation is usually caused by increased demand and production costs.

Here are some of the causes of inflation in more detail:

1. Increasing Demand

This increase in demand for certain commodities or services causes inflation. In this case, the increase in demand for these products or services occurs all at once.

This can be caused by several things, such as increased government spending, increased export demand, and increased private sector demand for commodities.

2. Increased Production Costs (Cost Pull Inflation)

Inflation caused by an increase in production costs, usually due to an increase in raw material prices.

Such as rising fuel prices and rising labor costs, this is what drives the increase in production costs.

3. High Money Circulation

Inflation also occurs when there is more money circulating in society than is needed. The price can go up to 100% when the commodity supply remains constant while it doubles.

Classification and Types of Inflation

Inflation can be divided into two categories based on where it comes from, such as inflation originating from within the country and inflation originating from abroad.

Internal factors such as budget deficits financed by the creation of new currencies and market failures lead to high food prices.

Meanwhile, inflation from abroad is inflation caused by an increase in import costs. Expensive goods manufactured abroad or increased import duties may be the cause.

Based on how much it affects prices, inflation can also be classified into several categories.

Covert inflation occurs when a price increase affects only one or two specific products. On the other hand, inflation is referred to as overt inflation if price increases affect all goods collectively.

Uncontrolled inflation is when the rate of inflation is so severe that prices keep changing and rising to the point where individuals cannot hold onto their money as it loses value.

The degree of inflation can also be distinguished based on:

Mild Inflation

Mild inflation, which is inflation that is still easy to control and does not really disrupt the country's economy. This usually happens because of rising prices or services below 10% per year.

Moderate Inflation

Moderate inflation is inflation that can reduce the welfare of people who have a fixed income. However, inflation is also not too dangerous for the country's economy.

High Inflation

High inflation is the most severe inflation that can result in price increases up to 6 times.

So that people no longer want to save money, because the value of money has fallen so badly.

So that it will be exchanged for money so that the velocity of money is faster and also the price rises in an accelerated manner.

This situation usually occurs when the government experiences a budget deficit which is financed by printing money.

Hyperinflation

Very high inflation (Hyperinflation), often known as inflation which is very detrimental to a country's economy.

And very challenging to manage despite monetary and fiscal policies. The annual inflation rate is between 100% and higher.

Types of Inflation Based on Causes

Inflation rates may differ from country to country or even within one country.

Consumer-driven inflation while production is at or near full employment, this inflation is the result of an increase in overall demand.

In conditions of almost full employment, price increases and increases in total demand both have the potential to increase output.

Price-driven inflation Cost-driven inflation, in contrast to demand-pull inflation, is typically characterized by rising prices and falling production.

Therefore, a recession occurs at the same time as inflation. Typically, this situation begins with a reduction in overall supply caused by an increase in production costs.

The successful trade union struggle for a raise is one of the reasons for this spike in production costs.

Managers can increase prices in the monopoly sector by exercising their influence in the market.

Impact of Inflation

A nation and its citizens are affected by inflation both positively and negatively. This effect can be observed in a number of aspects of people's lives.

Here are some general results of the impact of inflation:

1. Impact of Inflation on Income

On people's income, inflation can have both good and negative effects. This will motivate business owners to increase production in certain circumstances, such as when inflation is weak, to boost the economy.

However, because the value of money is fixed while the cost of a product or service increases, inflation will negatively affect people on a fixed income.

2. Against Interests

The majority of individuals will become less interested in saving during periods of inflation.

The reason is that while depositors have to pay administrative fees for their savings, the income from interest on savings is much lower.

3. Impact on Calculations

Because the cost of estimating commodity prices may be too small or too large under inflationary conditions, these calculations will be challenging.

It is often impossible to predict with certainty the amount of inflation that will occur in the future.

4. Against Exports

A country's ability to export will decrease when experiencing inflation because export costs will increase.

In addition, export goods are currently less competitive, thus affecting foreign exchange earnings.

5. Impact on Efficiency

The way the factors of production are allocated can also change as a result of inflation.

An increase in demand for various items can cause adjustments in the way some goods are produced, which can lead to an inefficient distribution of production elements.

Economic Growth and Inflation Too high inflation will not help economic growth.

Rising costs make profitable activities highly unprofitable.

Therefore, capital owners usually prefer to use their funds for speculative ventures.

This objective is achieved, among other things, by purchasing fixed assets such as real estate, houses and buildings.

Entrepreneurs will reduce productive investment and the level of economic activity as a result of their preference for this type of investment activity. As a result, more unemployment will arise.

The Role of the Central Bank in Controlling Inflation

Inflation management is largely under the control of the central bank. In most cases, a country's central bank works to keep inflation under reasonable control.

Some central banks even have independent authority in the sense that the government and other external parties are not allowed to interfere in their policies.

This is because many studies have shown that a less independent central bank will encourage higher inflation rates.

One reason is caused by government intervention intended to utilize monetary policy to stimulate the economy.

To manage prices, central banks usually use the money supply and interest rates. Domestic currency exchange rates must also be under the supervision of the central bank.

This is due to the fact that currency values can be both internal, as indicated by inflation rates, and external (exchange rates).

Currently, central banks around the world, incl Bank Indonesia, used an inflation targeting strategy extensively.

The following are three monetary policies used by the central bank to control the money supply:

Open Market Operations

In the same way it directs bond brokers to buy from the general public in the national bond market, central banks buy and sell sovereign bonds.

A country's money supply increases with the money the central bank issues for bonds. The government takes the opposite action to reduce the money supply.

Discount Rate

The lending rates for commercial banks covered by central bank regulations can be increased or decreased.

If commercial banks do not have sufficient reserves to meet reserve requirements, they can borrow from the central bank.

When the central bank makes loans to these commercial banks, the banking system has more reserves than it should, which allows it to generate more money.

Fewer banks are willing to borrow reserves from central bank, the higher the discount rate set by the central bank for commercial banks.

Consequently, when the discount rate rises, the banking system's reserves decrease, which in turn causes the money supply to decrease.

Minimum Cash Reserve Requirements

Minimum cash reserve requirements for commercial banks in a country can be increased or decreased by the central bank.

As minimum cash reserve requirements increase, banks are forced to maintain additional reserves, which limit their ability to borrow against each unit saved.

As a result, the money supply decreases and the reserve ratio rises. On the other hand, lowering the reserve requirement will increase the money supply, increase the multiplication of money, and reduce the reserve ratio.

FAQs

Here we have summarized some questions that are commonly asked in knowing what inflation is:

What Causes Inflation?

One of the main causes of inflation in developing countries, such as the government spending budget which has an impact on increasing the amount of money in circulation.

What Happens if there is no Inflation?

Actually, inflation is something that is needed as long as it is at a level that is within the reach of the country's capabilities.

So if there is no inflation then there will be no positive movement in the economy, which will not change prices at all.

Conclusion

That's a little information to get to know what inflation is further, complete with the role of the central bank.

And we can interpret this inflation to mean a continuous increase in prices for services and goods within a certain period of time, which if excessive can cause losses to the economic sector.