Inflation: Why Prices Keep Rising?

What is inflation? If you've noticed that your coffee has become more expensive or that groceries at the supermarket cost twice as much as last year, you're not alone. This phenomenon has a name: inflation. It is one of the most discussed economic topics today, and since it affects every person who handles money, it is worth understanding it in depth.

Inflation Is a Simple Phenomenon – Yet Complex

In its simplest form, inflation means that your money loses value. If today 100 euros can buy you a shopping basket, the same amount will buy you fewer things in a year. It is the steady decrease in the purchasing power of a currency – an almost inevitable feature of modern economies.

However, it is not merely a guild of one or two products. Inflation describes the general increase in prices of all goods and services in an economy – from food to housing and healthcare. And it is not a random event; it is a long-term orientation that persists over time. Governments around the world monitor inflation rates year by year, expressing the changes as a percentage increase or decrease compared to the previous period.

What Are the Main Causes of Inflation?

Essentially, there are two fundamental logics behind inflation. First, when there is too much money in circulation for a specific good or service – a case that historically occurred when gold and silver from colonial conquests flooded Europe in the 15th century. Second, when demand significantly exceeds supply, upward pressure on prices appears.

However, if we dig deeper, we can distinguish three different types of inflation that arise from different conditions.

Demand-Pull Inflation: When Everyone Wants to Buy

Imagine a local baker who produces 1,000 loaves a week. He usually sells exactly that amount and everything runs smoothly. But suddenly, due to improved economic conditions, customers have more money to spend. They request 2,000 loaves a week. The baker is already working at full capacity – he cannot produce more, at least not immediately. In this situation, he can raise prices, knowing that people will pay more for the product they desire.

This is demand inflation. It occurs when demand exceeds supply, causing prices to rise across all categories. It is the most common type of inflation and is directly related to increased consumption.

Cost-Push Inflation: When Expenses Skyrocket

Now, let's assume that the baker has expanded his production to 4,000 loaves per week. The demand and supply are balanced and everyone is satisfied. But suddenly, due to a poor harvest, wheat becomes scarce. The baker has to pay more for the same ingredients. Or, alternatively, the government raises the minimum wage, increasing his labor costs. In any case, he must raise the prices of his loaves to avoid losing profits – even if the demand has not increased.

Cost-push inflation arises from increased costs of raw materials or production. On a large scale, this can be caused by resource shortages, increased taxation, or a decline in exchange rates that makes imports more expensive.

The Native Inflation: The Phenomenon of the Self-Sufficient Cycle

There is a third type: inherent inflation, which arises from previous economic activity. When people and businesses expect that inflation will continue, they begin to act on this expectation. Workers negotiate higher wages to protect their wealth. Employers, in turn, raise the prices of their products. This creates a spiraling price-wage dynamic that can become self-sustaining and worsen over time.

How Can Governments Control Inflation?

As uncontrolled inflation can nullify savings, governments have developed various tools to curb it.

Increase in Interest Rates

The most common tool is the increase in interest rates by central banks. When interest rates rise, borrowing becomes more expensive. For consumers, this means that credit is less attractive, leading to reduced spending. Saving, on the other hand, becomes more attractive as savers earn interest. The result is lower demand and – theoretically – lower pressure on prices.

Change of Fiscal Policy

An alternative approach is the modification of fiscal policy. If governments increase taxes, then people have less disposable income, resulting in lower demand and theoretically lower inflation. However, this strategy is politically dangerous, as the public often reacts negatively.

How is Inflation Measured?

To combat inflation, governments must first measure it. The primary way is by monitoring a price index – the most widely used is the consumer price index (CPI).

The CPI takes into account the prices of a wide variety of products, using a weighted average of a typical household's shopping basket. Data is collected from thousands of locations and compared over time. For example, if the CPI was 100 in the “base year” and 110 two years later, this means that prices increased by 10% during that period.

The Advantages of a Controlled Inflation

It may seem strange, but a low inflation rate is not necessarily bad. In fact, it has certain benefits:

Encouragement of Spending and Investment: Knowing that money will be worth less tomorrow, people and businesses are more willing to spend and invest today. This stimulates economic growth.

Higher Profits for Businesses: Companies can raise their prices not only to cover increased costs but also to gain additional profit margins. This often promotes capital investment and job creation.

Better than Deflation: Deflation – where prices fall – is much worse for economies. In deflationary conditions, consumers delay purchases hoping for even lower prices, which reduces demand and can lead to high unemployment.

The Disadvantages of High Inflation

However, when inflation becomes high or unstable, problems begin:

Wealth Erosion: High inflation destroys saved wealth. If you hide 100,000 euros under your mattress, in ten years it may have the purchasing power of less than 50,000 euros.

Hyperinflation: At its extremes, high inflation can spiral into hyperinflation – where prices increase by more than 50% per month. This effectively destroys currencies and economies.

Uncertainty and Inactivity: In times of high inflation, economic uncertainty arises. Both households and businesses become cautious with spending and investments, waiting to see what the economy will do. This can slow down growth and innovation.

The Final Result

Inflation is a complex phenomenon that cannot simply be “eliminated”. Instead, it needs to be balanced. A low, stable inflation rate is considered ideal for most modern economies. Dependence on flexible monetary and fiscal policies has proven to be the most effective way to keep inflation in check – however, it requires careful implementation to avoid over-correction that could cause further damage.