Inflation is a sustained rise in the general price level leading to a fall in the purchasing power or value of money.The greatest falls in the value of money came during the mid-late 1970s and then in 1980s.
Inflation reduces the value of money. When prices are increasing, then the value of money falls.
Price deflation is when the rate of inflation becomes negative. I.e. the general price level is falling and the value of money is increasing. Some countries have experienced deflation in recent years – good examples include Japan and China. In Japan, the root cause of deflation was slow economic growth and a high level of spare capacity in many industries that was driving prices lower. In China, economic growth has been rapid – but the huge amount of capital investment and rising productivity has led to economies of scale being exploited and a fall in production costs.
The main causes of inflation
Inflation can come from several sources: Some come direct from the domestic economy, for example the decisions of the major utility companies providing electricity or gas or water on their prices for the year ahead, or the pricing strategies of the leading food retailers based on the strength of demand and competitive pressure in their markets. A rise in government VAT would also be a cause of increased domestic inflation because it increases a firm’s production costs.
Inflation can also come from external sources, for example an unexpected rise in the price of crude oil or other imported commodities, foodstuffs and beverages. Fluctuations in the exchange rate can also affect inflation – for example a fall in the value of sterling might cause higher import prices – which feeds through directly into the consumer price index.