The term inflation is used to describe an increase in the price of goods and services relative to the currency in use. When the supply of currency is increased relative to the supply of goods and services, the currency itself becomes less valuable and it takes more of it to buy the same amount of goods and services. The value of the dollar decreases and the prices of goods and services increase.
What causes inflation?
The primary cause of inflation is an increase in the supply of currency. When the government or central bank increases the money supply, it devalues the currency. The more currency that is created, the less valuable each individual dollar becomes.
Is inflation good or bad?
Inflation hurts the average consumer by eroding the value of their wage and savings. It also makes it hard to plan how to spend money over the long-term because the future value of the currency is uncertain. The money supply must be managed to ensure that the value of currency remains relatively stable. If the money supply is not carefully controlled, then the currency becomes worth less and prices of goods and services rise.
Look and see whether your wage has kept up with inflation using our inflation wage calculator.
Why does the government want inflation?
Inflation can be beneficial to the government if it is used to cover up a money shortage. If the government does not have enough money to pay for all of the goods and services it purchases, it can create new currency to cover the deficit. This gives the government a way to cover its spending without raising taxes directly. Instead, the additional value is taken from the holders of the currency through the loss of their purchasing power. Inflation also allows the government to pay its debts with currency that is worth less than the amount it borrowed.
What is hyperinflation?
Hyperinflation is an extreme form of inflation that occurs when the money supply greatly exceeds the value of goods and services that the currency can buy. A government experiencing hyperinflation will have devalued the currency to such a degree that it is worthless. This can be evidenced by the large amount of currency that is required to buy basic goods and services.
What causes hyperinflation?
Hyperinflation is caused by a rapid increase in the supply of currency. The increase in the money supply is usually a result of government spending. By paying for goods and services with a money substitute that has no absolute value, the government avoids having to raise taxes to cover its spending. The money substitute can be created in almost unlimited quantities, which allows the government to pay for goods and services without having the revenue to back them up. This can lead to hyperinflation.
How can investors protect themselves from inflation?
Investors can protect themselves from the inflation of their dollar by buying assets that retain their value over time. This includes gold, real estate, cryptocurrency, or shares in companies that produce goods and services. Investing in an asset that increases in value over time will help to offset any losses in the value of the investor's currency. The investor can sell the asset at a later date when the currency has declined in value to offset their losses.
To help protect yourself from inflation, read our article on investing strategies.