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  Inflation occurs when prices rise rapidly for goods and services. A classic case of extreme inflation was the hyperinflation in Germany after World War I, when prices rose so rapidly that printing presses could not keep up by printing new currency of larger denominations; larger numbers were stamped on top of already issued currency. Money to buy everyday items literally required a wheelbarrow to carry it around. The entire monetary system collapsed.

In the US, consumer price index increases of 5% or 6% are considered inflationary, while double-digit increases such as those in the late 1970s cause grave concern. In the 1980s, a number of countries experienced inflation rates of 50%, 80%, 100% and some more than 1000%, rates which were economically and politically destabilizing. Prices of consumer goods and services in an inflation usually outrun most prices of factors of production.

Rises in consumer prices steadily erode the purchasing power of a given currency unit. Inflation would matter little if it was smooth, uniform, and all incomes were adjusted perfectly in line. But it does not work like that. Creditors and those on fixed income, such as many retired persons, lose purchasing power during inflation. Debtors gain by paying back money of lesser purchasing power than when the money was borrowed.

Economists differ in their analysis of the causes of inflation, and therefore in their prescribed cures. Monetarism holds that inflation can be reduced only by slowing down the growth of the money supply: in the words of the economist Milton Friedman, ‘inflation is always and everywhere a monetary phenomenon’. Many Keynesians (see Keynesian Theory), by contrast, tend to believe that inflationary pressures can exist independently of monetary conditions; to run a modern economy at low inflation and low unemployment, they say, governments need an incomes policy. TF

Further reading J.M. Keynes, A Tract on Monetary Reform; , Thomas Sargeant, Inflation.



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