Definition of inflation
What is inflation?
Inflation is a measure of the general increase in the prices of goods and services in a country or geographical area. The higher the inflation, the more the currency loses value. This is therefore a loss of purchasing power for all economic actors (households, companies, the country, etc.). In times of inflation, you need more money (at the inflation rate) to purchase your goods and services. For example, if the inflation rate is 1%, it means that your supermarket basket will cost you 1% more. However, that is a simplified view of inflation. Inflation is a global measure of price inflation and some goods or services experience higher inflation than others.
Calculation of the inflation rate
Inflation is calculated using the consumer price index (CPI). This is the official indicator used to measure the level of price increases. The indicator is calculated on a basket of goods and services. However, this measure of inflation is incomplete. It only takes into account the increase in prices on goods and services consumed by households. But, companies are also economic agents and are the first to be affected by inflation. Effectively, if the currency loses value, they can buy less raw materials, products, etc. This is why the inflation rate, benchmarked by countries and central banks, is theproducer price index (PPI).
Inflation: friend or foe?
Inflation is often perceived by households as very bad for their money. Yet, the consequences of inflation are not necessarily bad. It can be a sign of economic growth in the country. It really depends on the level of inflation. It must be linked to the rate of the country’s economic growth. Effectively, the real growth of a country is calculated as follows: Growth rate - inflation rate.
If inflation is too high (the level of inflation is higher than the growth rate in the country), it is a value destroyer for economic agents. It is a factor of social inequalities.
If it is moderate (the level of inflation does not exceed the growth rate), inflation might have no consequences. Indeed, the level of wages is adjusted in line with price trends. There is therefore no loss of purchasing power.
The last element to consider when measuring the impact of inflation on your purchasing power is the level of your debts and savings. If you have a bank loan, inflation is beneficial. Inflation enables you to repay your debt to the bank with money of a lower value, compared to when the loan was taken out. If you have savings, inflation makes it lose value. It is therefore important that the return on your savings is higher than the inflation rate.
Different types of inflation
Moderate inflation: The inflation rate does not exceed 2%. This is the reference rate set by the European Central Bank. Monetary authorities aim for this type of inflation (between 0 and 2%), which is often beneficial for the country. To achieve this objective, central banks can influence the level of the money supply (currency in circulation).
Creeping inflation: The inflation rate is 2% to 4% (this can go up to 5% at a peak). At this level, it is often a warning signal for central banks. They must then control the money supply to prevent inflation from having an excessive impact on the country's real growth.
Walking inflation: The inflation rate is 5% to 10% (with peaks up to 20%). Monetary authorities must then urgently put in place a policy to fight inflation. For economic agents, open inflation is a sign of a very heavy loss of purchasing power.
Galloping inflation or hyperinflation: The rate exceeds 20%. The value of the country's currency is in free fall and this is leading the country into a severe recession. In some cases, this leads to bankruptcy. This is what happened, for example, during the Argentinean crisis and in Zimbabwe.