Inflation Essay, Research Paper

In the 1970s the prices of most things Americans buy more than doubled. Such a

general increase in prices is called inflation. Of course prices of selected

goods may increase for reasons unrelated to inflation: the price of fresh

lettuce may rise because unseasonably heavy rainfall in California has ruined

the lettuce crop, or the price of gasoline may rise if the oil-producing

countries set a higher price for oil. During inflation, however, all prices tend

to rise.

Over the last 400 years there have been many periods of inflation. In the

16th century, when the Spaniards began bringing back gold and silver from the

New World, prices in Western Europe moved upward as the supply of money

increased. During the 19th century prices tended to go downward as food and raw

materials became cheaper. After major wars such as the Napoleonic Wars and World

Wars I and II, prices again moved upward. In the 1950s and ’60s a so-called

creeping inflation occurred, when the general price level in the United States

and Western Europe rose by an average of 1 to 5 percent each year. In the 1970s

inflation increased until it reached as much as 13 percent a year in the United

States.

Many countries have suffered from inflation more than has the United States.

Israel had inflation of more than 100 percent a year in the early 1980s, meaning

that the cost of living more than doubled every year. In Argentina inflation was

greater than 400 percent in 1975 and averaged more than 100 percent each year

from 1976 to 1982. The most remarkable inflation in modern times was the German

hyperinflation of 1923, when people went to the store with wheelbarrows full of

money to buy a few groceries. A similar hyperinflation occurred in Hungary after

World War II.

Inflation has been defined as too much money chasing too few goods. As prices

rise, wages and salaries also have a tendency to rise. More money in people’s

pockets causes prices to rise still higher so that consumers never quite catch

up. Inflation can go on continuously year after year so long as the money supply

continues to increase.

Continued inflation affects people in diverse ways. Those who live on fixed

incomes, or those whose incomes increase very slowly, suffer most from inflation

because they are able to buy less and less. Those who lend money when prices are

lower may be paid back in dollars of reduced purchasing power. Banks and savings

and loan associations generally lose from inflation. People who borrow money,

however, may profit by paying their debts in dollars that have shrunk in

purchasing power. Inflation thus encourages borrowing and discourages saving. It

also leads people to buy real estate and durable goods that will keep their

value over time. In the United States this tendency is reinforced by the tax

system, which allows taxpayers to deduct property taxes and interest payments

from their taxable incomes. If inflation continues for a long time, the country

as a whole may begin to consume more and invest less as people find it more

profitable to borrow than to save. In other words, inflation causes society to use more of its resources for today’s purposes and

to set aside less for tomorrow’s needs.

Causes of Inflation:

Inflation has many causes, but they all operate to raise the demand for goods

and services beyond the capacity of the ecomomy to satisfy that demand. Often

inflation follows a war, when the government has spent vast sums on military

equipment and has not raised taxes enough to pay for it. Heavy government

spending in peacetime may also lead to inflation. The principal reason why

governments create inflation is that they are able to print money. When a

government pays its bills by printing money rather than by raising taxes, the

effect is to increase the demand for goods and services. If demand is already

high, increasing it will only push up the prices of those goods and services.

But the government may not be the only player in the inflation scenario.

Citizens, through their voting power, encourage the government to follow

inflationary policies. In the United States special interest groups often exert

pressure on Congress for programs that will benefit them at the expense of the

treasury. Few taxpayers actually ask their Congressional representatives to

raise taxes. Government deficits in themselves do not necessarily lead to

inflation, but they make it more difficult to prevent inflation or to slow it

down.

Another part in the scenario is played by people’s efforts to protect

themselves from the effects of inflation. Consumers want their incomes to

increase so as to keep up with rising prices. Those who belong to unions may put

pressure on employers to raise wages, a factor that tends to force up prices

still further. Those who lend money expect to be paid back in inflation-adjusted

dollars. Retired people want their social security and other pension payments to

increase with the cost of living. As inflation continues, people expect it to

become even worse and try to compensate for it in advance. The simple

expectation of inflation thus helps to keep it going.