Chapter 6. Inflation
Introduction to Inflation
Watch It
How would you like to pay $417.00 per sheet of toilet paper? Sound crazy? It’s not as crazy as you may think. Here’s a story of how this happened in Zimbabwe.
Around 2000, Robert Mugabe, the President of Zimbabwe, was in need of cash to bribe his enemies and reward his allies. He had to be clever in his approach, given that Zimbabwe’s economy was doing lousy and his people were starving. Sow what did he do? He tapped the country’s printing presses and printed more money.
Clever, right?
Not so fast. The increase in money supply didn’t equate to an increase in productivity in the Zimbabwean economy, and there was little new investment to create new goods. So, in effect, you had more money chasing the same goods. In other words, you needed more dollars to buy the same stuff as before. Prices began to rise — drastically.
As prices rose, the government printed more money to buy the same goods as before. And the cycle continued. In fact, it got so out of hand that by 2006, prices were rising by over 1,000% per year!
Zimbabweans became millionaires, but a million dollars may have only been enough to buy you one chicken during the hyperinflation crisis.
It all came crashing down in 2008 when — given that the Zimbabwean dollar basically ceased to exist — Mugabe was forced to legalize transactions in foreign currencies.
Hyperinflation isn’t unique to Zimbabwe. It has occurred in other countries such as Yugoslavia, China, and Germany throughout history. In future videos, we’ll take a closer look at inflation and what causes it.
“Zimbabwe and Hyperinflation” video by MRU is licensed under CC BY-ND 2.0.
Introduction to Inflation
In this chapter, you will learn about:
- Tracking Inflation
- How to Measure Changes in the Cost of Living
- How the U.S. and Other Countries Experience Inflation
- The Confusion Over Inflation
- Indexing and Its Limitations
Inflation is a general and ongoing rise in the level of prices in an entire economy. Inflation does not refer to a change in relative prices. A relative price change occurs when you see that the price of tuition has risen, but the price of laptops has fallen. Inflation, on the other hand, means that there is pressure for prices to rise in most markets in the economy. In addition, price increases in the supply-and-demand model were one-time events, representing a shift from a previous equilibrium to a new one. Inflation implies an ongoing rise in prices. If inflation happened for one year and then stopped, then it would not be inflation any more.
This chapter begins by showing how to combine prices of individual goods and services to create a measure of overall inflation. It discusses the historical and recent experience of inflation, both in the United States and in other countries around the world. Other chapters have sometimes included a note under an exhibit or a parenthetical reminder in the text saying that the numbers have been adjusted for inflation. In this chapter, it is time to show how to use inflation statistics to adjust other economic variables, so that you can tell how much of, for example, we can attribute the rise in GDP over different periods of time to an actual increase in the production of goods and services and how much we should attribute to the fact that prices for most items have risen.
Inflation has consequences for people and firms throughout the economy, in their roles as lenders and borrowers, wage-earners, taxpayers, and consumers. The chapter concludes with a discussion of some imperfections and biases in the inflation statistics, and a preview of policies for fighting inflation that we will discuss in other chapters.
