Understanding Economic Inflation: Definition, Causes, Effects, and Mitigation

Economic inflation 

Economic inflation is the emergence of a relative change in the general price level by relying on the use of the consumer price index, because it contributes to clarifying the amount of supply of services and goods, whether imported or locally produced, and economic inflation is defined as a continuous increase in prices for services and products, and government authorities have not been able to impose control over them.

Another definition of economic inflation is a gradual rise in prices that appears as a result of an expansion in supply or demand or an increase in costs.

The reasons for the emergence of economic inflation 

Inflation is one of the economic phenomena caused by a set of reasons, the most important of which are:

• The emergence of an increase in aggregate demand: Contemporary theories of inflation explain the emergence of excessive demand for services and products, meaning an increase in demand over supply, so the prices of products are determined when an equivalence between demand and supply appears, and when an excess of demand appears for a certain reason while supply continues to be normal, then the prices of these products rise. 
• The emergence of a decrease in total supply: It is the occurrence of an economic imbalance resulting from a decrease in total supply, due to a set of factors, including: 

1. Full employment, that is, the economy reaching a stage where it depends on the operation of all elements of production, which leads to the inability of the productive system to provide all the needs of high demand. 
2. Insufficient production, as it may lose its flexibility, as it cannot provide the market with high-demand products, due to the lack of technical factors for production or the use of outdated production methods that do not meet the modern requirements of the market. 
3. Lack of productive elements, such as raw materials and employees. 

• High costs of production: It is the emergence of an increase in the prices of services and products due to the increase in production costs, and the increase in production costs is defined as the rise in the prices of services for productive factors at a rate that exceeds their marginal production, so the apparent increase in the costs of production factors with the stability of production leads to a rise in the unitary production cost, which leads to an increase in the selling price, and if the selling price does not rise, this leads to a decrease in profits. 
• Dependence on imported services and goods: It is a reason that appears in small economic sectors, which are affected by other economic sectors that depend on importing most of their needs of services and products from abroad, and this leads to the emergence of an accelerated rise in the prices of these products and services, which affects their selling prices that rise in local markets. 
• Wars and natural disasters: Wars and natural disasters affect the economy of countries, leading to a decline in production and a reduction in the proportion of supply, which leads to an increase in the rate of inflation, and this results in an increase in general economic problems, such as the emergence of turmoil in the local currency, and the emergence of a budget deficit . 
• The effect of bank interest: where banks do not maintain the full value of deposits, but a small percentage of them, which leads to the issuance of money for deposits in large times that results in a rise in the money supply, which contributes to the emergence of monetary inflation, and reliance on financial loans as a means to reduce the apparent gap between demand and income. 

Effects of economic inflation 

Economic inflation leads to the emergence of many negative effects on the economy, including:

• Impact on the distribution of real national income: It is the total quantities of services and goods obtained by individuals based on their cash income, and the impact of inflation on real national income appears according to the following cases: 

1. Cash income remains stable as prices rise continuously, leading to a continuous decline in income. 
2. Cash income increases by a smaller percentage than the increase in prices, which leads to a decrease in real income by a smaller percentage. 
3. Increasing cash income by an equal percentage with the increase in prices, which leads to the stability of real income. 
4. Cash income increases by a greater percentage than the increase in prices, which leads to an increase in real income. 

• The impact of the purchasing power of money: It is the loss of money to part of its purchasing power, resulting from the continuous increase in prices, which leads to a weakening of confidence in the national currency, and this encourages individuals to buy products, foreign currency, and real estate. 
• Negative impact on the balance of payments: As a result of the increase in inflation rates, which leads to an increase in the production of domestic goods, the competitiveness of these goods decreases in global markets, resulting in a decline in the volume of exports, and an increase in demand for imported products with low prices compared to similar local products. 
• Affected wealth distribution: It is the random redistribution of the wealth of society during the period of the emergence of inflation, so individuals sell their real wealth such as real estate as a result of the continuous increase in prices, in order to maintain their level of consumption that they are accustomed to, while individuals who own financial wealth will lose part of its real value due to the increase in prices and the decrease in the purchasing power of income. 

Read alsoUnderstanding Economic Inflation: Definition, Causes, Effects, and Mitigation

Read alsoUnderstanding Economic Inflation: Definition, Causes, Effects, and Mitigation

Read alsoUnderstanding Economic Inflation: Definition, Causes, Effects, and Mitigation

Read alsoUnderstanding Economic Inflation: Definition, Causes, Effects, and Mitigation

Means of reducing economic inflation 

There are a set of means that help reduce the impact of economic inflation, namely:

1. Relying on the role of the Ministry of Finance in setting the state's fiscal policy, which helps identify sources of revenue, and the surplus resulting from the budget, which leads to reducing the amount of liquidity available, and this contributes to reducing the rate of inflation. 
2. Raising the tax rate on luxury products traded by high-income individuals. 
3. Reducing government expenditures because it is one of the means that lead to increasing the money circulating in the markets, so reducing expenses contributes to reducing the money circulating in the market. 

Calculation of the economic inflation rate 

The economic inflation rate constitutes a percentage in which the value of currencies decreases during a certain period of time, resulting in an increase in the general price rates of products, and the economic inflation rate is calculated in accordance with the following law:

Economic inflation rate = (general price level during a year - general price level in the previous year) / general price level in the previous year × 100% 

Example: The price level in 2017 reached $ 500, compared to its level in 2016, which reached $ 450, what is the economic inflation rate? 

Solution: By applying the previous law and replacing the data of the example in it: 

Economic inflation rate = 500 - 450 / 450 × 100% = 11,11%