What is Inflation?

What is Inflation
Inflation can be defined as a constant increase in the general price of goods and services. In the case of inflation, which exhibits the opposite pricing behavior of deflation, the goods and services in the market, that is, the general price levels in the relevant economy, tend to constantly increase. In this article, you can find answers to the questions what is inflation, why does it increase, what are the types of inflation, how does it decrease, what are the effects of inflation.

What is Inflation?
Inflation is used to describe the ongoing upward trend in general price levels. In inflationary economies, prices of goods and services tend to increase, and in parallel, the purchasing power of the currency decreases. Inflation can also be defined as the reflection of supply or demand-induced imbalance in any economy. The same imbalance applies to deflation.

General price level; It is the value of the prices of goods and services sold in an economy, weighted according to their share of the average consumer's expenditures during the year. The change in the general price level is monitored from the basket created from goods and services whose prices are monitored during a certain period. In short, this basket is actually an index. Index is the standardized value of a data or group of data. In other words, goods and service items (data group) whose prices are monitored are converted into a standard value, that is, CPI data. However, the inflation basket is updated every year.

Inflation data is generally calculated as percentage change compared to the same period of the previous year (annual) and percentage change compared to the previous month (monthly), as well as the percentage change rate compared to December of the previous year and the percentage change rate based on twelve-month averages (annualized). It also has alternative calculation methods, including Additionally, it is also possible to calculate inflation data for any period by accessing raw index data.

Inflation, disinflation and deflation, which represent different behaviors in price levels; It is measured using the consumer price index (CPI), producer price index (PPI) and gross domestic product deflator. The consumer price index (CPI) measures price changes in a basket of consumer goods. Producer price index (PPI) measures the producer prices of products produced and sold domestically. The gross domestic product deflator is an inflation indicator that measures broader economic activity. However, while taxes are included in the CPI calculation, taxes are excluded from the PPI calculation.

Apart from CPI and PPI data, there are also inflation calculations or indicators that evaluate different pricing behaviors. Core CPI data, which is an inflation indicator preferred by central banks; CPI's food, energy, gold etc. It is free of pencils. While CPI also includes temporary price shocks (geopolitical developments, natural events, taxes, etc.), core CPI tries to detect the main trend of price movements by excluding such effects. In addition, other inflation data can be listed as services PPI, agricultural products PPI, agricultural input price index and foreign PPI.
Why Does Inflation Rise?

Inflation occurs as a reflection of supply or demand-induced imbalance in any economy. While the factors that cause inflation to rise may be demand or supply-related, inflation may also occur due to structural reasons.

Demand Inflation

Inflation occurs when the money supply in any economy moves above the total level of goods and services produced and imported. In other words, if the rate of increase in money supply exceeds the rate of economic growth, the general price level may tend to increase. Except when the money supply in the economy moves above the total level of goods and services produced; Inflation may also occur if the demand for limited goods and services increases. However, in demand-driven inflation, consumers' expectations may tend to deteriorate, that is, they may tend to bring forward their spending because they expect prices to increase in the future.

Cost Inflation

Cost inflation is supply-driven inflation. It is caused by increases in production factors or input prices. If costs increase, manufacturers can cause inflation in two ways. First, production may be reduced as a reflection of increasing costs, that is, supply may be reduced. In this case, the price of goods and services may tend to increase since there will be a lower supply against a constant demand. Secondly, instead of reducing supply, producers may choose to pass on the costs to the consumer. So they may increase prices. In this case, the reflection of general price levels will cause inflation.

Structural Inflation

Structural inflation is related to the deterioration of inflation expectations. In an inflationary environment, consumers tend to bring forward their spending because they expect prices to rise in the future. Therefore, inflation expectations tend to remain constantly high. Another factor that may cause structural inflation can be considered as imperfect competition conditions on the supply side.
How to Reduce Inflation?

In the economics and finance literature, it is accepted that fighting inflation is easier (under certain conditions) than deflation. To combat inflation, monetary tightening is implemented and the money supply in the economy is reduced. Central banks; It tries to direct the money supply and therefore inflation expectations through monetary policies, especially interest rates. On the other hand, governments play a complementary role with central banks through financial policies, especially taxes and expenditures. However, governments may try to control general price levels with certain incentives and other practices that will increase production.

Disinflation is used to describe situations where the rate of increase in inflation slows down. In a disinflationary environment, general price levels continue to rise more slowly than in previous periods. In simple terms, as the rate of inflation decreases, prices are still rising, but at a slower rate.

What are the effects of inflation?

Keeping inflation under control is important for economic stability. Inflation at a certain level is important in terms of encouraging economic growth.

In inflationary economies, prices of goods and services tend to increase, and in parallel, the purchasing power of the currency decreases. As a reflection of this situation, consumers tend to bring their spending forward. On the other hand, in an inflationary environment, the real value of debt decreases. The relative value of holding cash decreases and asset prices tend to increase.

Another reflection of inflation may be a decrease in investments as it may increase borrowing costs. High inflation may reduce investors' willingness to take risks, which may have a negative impact on economic growth. However, high inflation may cause businesses to lay off workers to reduce costs.
What are the Types of Inflation?

moderate inflation,
It is a slow and steady increase in general price levels. In other words, although it varies from institution to institution and country dynamics, moderate inflation can also be defined as the inflation level targeted by central banks. Moderate inflation supports economic growth and preserves purchasing power.

high inflation,
It is a situation where general price levels increase rapidly. In case of high inflation, the gap between incomes and prices widens. People's purchasing power is decreasing and economic growth is slowing down.

hyperinflation,
It refers to an extreme situation where inflation increases very rapidly. In this type of inflation, prices rise within hours or days.

How can you protect yourself from inflation?

In an inflationary environment, the relative value of holding cash decreases as the purchasing power of the currency decreases and asset prices tend to increase. Therefore, individuals may choose to invest in various capital market instruments, especially stocks, in order to protect their purchasing power.