You have probably seen that prices are rising; the same amount of money you spent on groceries is not enough anymore. But why is that? Because of inflation. Europe has been at its highest level of inflation in decades, and there are many reasons for that. Economists generally think that the higher rates of inflation and hyperinflation are caused by the unrestrained increase of the money supply. The consensus view is that a long continuous period of inflation is caused by the money supply rising faster than the rate of growth in the economy. Covid did set up some people in an even worse situation with money, and the European central bank tried to save that by pushing more money on the move. They put too much money on the move, which is one of many reasons to feed inflation. Another reason is the demand-pull effect. It occurs when an increase in the supply of money and credit stimulates the overall demand for goods and services to increase more rapidly than the economy’s production capacity. This raises demand, which causes price hikes. More money leads to happier consumers since more individuals have more money. Consequently, more money is spent, which raises prices. Higher demand and a less adaptable supply lead to a demand-supply mismatch, which increases costs.

To fix this situation and lower inflation, central banks will raise interest rates, reducing the number of new loans. When people take fewer loans, they will spend less too. That will bring balance to supply and demand.

Inflation affects economies in several positive and unfavorable ways. The negative consequences of inflation include an increase in the opportunity cost of carrying money, doubt about future inflation, which may deter investment and savings, and, if inflation were fast enough, shortages of goods as consumers begin hoarding out of concern that costs will increase in the future. At the same time, people who own tangible assets like real estate or stockpiled commodities valued in their home currency may prefer to see some inflation since it will increase the value of their possessions, which they can sell for more money.

Inflation is defined as a continuous increase in the overall level of prices for goods and services in a region and is measured as an annual percentage change. To put it another way, as inflation rises, every dollar you have has purchased a smaller share of goods or services. When prices increase, and alternatively, when the value of money falls, you have inflation.

The hyperinflation that hit the German Weimar Republic in the early 1920s is a well-known example of inflation.

The countries that won World War I wanted reparations from Germany, but this was impossible because German paper money was worthless because of government borrowing. Germany made an effort to produce paper money to buy foreign currencies and pay off its debts. Due to this policy, the German mark depreciated quickly, and hyperinflation followed the progression. German consumers reacted to the cycle by trying to spend their money as soon as possible, realizing that the longer they waited, the less valuable it would become. Money kept pouring into the economy, and its value fell so low that people started taping useless bills to their walls. Similar circumstances occurred in Zimbabwe between 2007 and 2008 and Peru in 1990.

Jasse Heikkilä