What is the concept of inflation?

What is the concept of inflation?

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Inflation is one of the main topics in economic studies. The amount of inflation is very influential on the economic growth of a country.

Inflation is often used as an excuse for not achieving economic growth targets.

Not infrequently inflation is also used as a campaign tool for prospective leaders to win the votes of the voters, with promises to control it.

Even in 1974, the then president of the United States, Gerald R. Ford, declared that inflation was the number one enemy of the United States.

Therefore, in this paper we will learn about the nature of inflation, the factors that cause inflation, and economic policies to control inflation.

1. BASIC CONCEPTS OF INFLATION.

As a start, we will study the basic concept of inflation.

Blanchard states that inflation is  a sustained rise in the general level of prices’ (Blanchard, Olivier,  Macroeconomics , 4th edition, 2006).

Sementara Samuelson dan Nordhaus menyebut inflasi (inflation or inflation rate) sebagai ‘the percentage of annual increase in a general price level’ (Samuelson, Paul A., and William D. Nordhaus, Economics, 7th edition, 2002).

In principle,  inflation is a general increase in prices, which occurs within a certain period .

The price increase can be seen from  two points of view , namely:

  • a broad perspective ( broad perspective ) , for example the increase in prices for goods/services, as well as an increase in the cost of living .
  • a narrow perspective , for example an increase in the price of consumption products such as chili, onions, or rice.

The inflation rate is measured in percent ( rate ) . One  method of measuring inflation  is  to know the size of the consumer price index (CPI)  or  consumer price index  (CPI).

The CPI figure is obtained by  calculating the cost of living for household consumers (especially those living in urban areas) , including the cost of consumption of goods and services, housing costs (including rent), and other daily living costs, within a certain period of time.

Furthermore , the figures obtained are  compared with the index figures in the base year . This base year index becomes the benchmark for every measurement of inflation.

The comparison produces a number/index called the consumer price indexThe percentage change in CPI  from a certain period of time is  called  consumer price inflation ; In simple language: inflation or the rate of inflation .

For example: the CPI figure in the base year is 100, while this year the CPI calculation reaches 105, the inflation rate this year is 5% ((105/100) – (100/100))x 100%).

For information, there is the term  core consumer inflation , which  describes the calculation of the cost of living for consumers, by excluding the prices of certain  products that are seasonal in nature (seasonal products usually experience a price increase that exceeds reasonableness due to increased demand, for example ahead of religious holidays, nearing the end of the year, etc.). etc).

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Public policy makers tend to pay more attention to the calculation of  core consumer inflation , because price changes that occur are relatively stable.

In addition, economic policy makers will also  try to keep the inflation rate within a certain range , as  a symbol of economic stability from time to time .

Moreover, a stable inflation rate will facilitate economic policy making. Various economic studies have also stated that if inflation exceeds a certain target, it can trigger further inflation at a more severe level if it is not addressed immediately.

Actually  there is no certain benchmark related to the inflation rate that is considered reasonable , however, there is a range that can assist economic policy makers in determining the inflation rate targeted in one economic year, namely:

  • inflation rate  is 0% – 2.5% , meaning that  the economy is in a stable condition .
  • inflation rate  2.5% – 5% , indicating  a moderate inflation rate .
  • inflation rate  5% – 8% , including high inflation category  .
  • The inflation rate  is above 8% , meaning that  the economy is entering a dangerous inflation phase , with a further impact in the form of hyperinflation.

(Hellerstein, Rebecca, The Impact of Inflation, Federal Reserve Bank of Boston, 1997).

On the other hand,  inflation below 0% is called deflation or  negative inflation .

A more complete discussion of the Consumer Price Index ( Consumer Price Index ) and the calculation of the inflation rate can be read in the articles on the Consumer Price Index, Producer Price Index, and Determination of the Inflation Rate.

2. INFLATION TRIGGER FACTORS.

Inflation can arise as a result of the implementation of fiscal and monetary policies .

In terms  of monetary policy , for example,  increasing the money supply  or  decreasing the benchmark interest rate .

The description is as follows:

  • when the money supply increases , then  the value of money will decline .
  • This policy is actually only natural to spur an increase in consumption, but  when the decline in the value of money is greater than the size of the economywhat happens is the increase in product prices  as an adjustment to the decline in the value of money.

Regarding  fiscal policy , for example, when  the government increases spending  , this triggers an increase in demand .

However ,  when  demand  exceeds  supply , there will  be a shortage of production resources , resulting  in an increase in product prices . This condition is known as  demand-pull inflation .

Changes in product supply can also  trigger inflation  ; namely  when  supply shocks occur , for example  when natural disasters occur  which result in  an increase in production costs . This has  an impact on reducing the quantity of product inventory, thus inflating prices .

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In other words,  inflation occurs because of disruptions to product inventories . This phenomenon is known as  cost-push inflation .

3. INFLATION CONTROL POLICY.

With so many factors triggering inflation, economic policy makers must be careful in every fiscal, monetary policy decision, as well as in maintaining a balance of  demand  and  supply .

If there is unexpected inflation, certain policies can be applied, for example  the central bank conducts a  contractionary policy , namely by  raising the benchmark interest rate , so that it can suppress demand (some economic actors will hold their money and not use it for consumption).

In addition, the central bank can also  tighten the rules for obtaining credit (loans) . In general, policies like this in the short term can have a negative impact on the economy, for example on the housing sector.

There is one  expression in an effort to overcome inflation , namely  ‘the problem must intentionally be made worse before it gets better!’ , meaning  that economic conditions must be made ‘ worse ‘ in the short term, before improving in the long term .

It can be concluded that managing the inflation rate so that it remains stable is the best step, because if inflation is out of control, the costs to be incurred will be very expensive.

Meanwhile,  if the cause of inflation comes from global factors , then  a country’s economic policies will not have a significant effect . The global economic slowdown in 2007-2008 proved that when there was a sharp increase in world crude oil prices, many countries did not have the ability to control it.

At that time, the policies taken were generally in the form of increasing subsidies and/or reducing the state budget in certain sectors to minimize the impact of inflation.

This is a description of the basic concept of inflation, the factors that trigger inflation, and economic policies to overcome it. **


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Economics Student of Universitas Gadjah Mada, Indonesia.