The price of money has not stayed the same since it was first invented. This might feel like common sense to you: of course the coins people used to use as currency don’t mean the same as a pound, euro, or dollar bill of today. However, the factors that have contributed to the changing price of money are often far more complicated than people might think. Inflation is a common explanation for changing monetary value thrown around in news headlines, on morning news reports, and in international finance columns across the world, but few people understand what exactly inflation means. Inflation is a big deal, and it’s literally changing the price and value of our money every minute.
What is Inflation?
Inflation refers to the change in value of money over time, specifically, the lowering of the value of money. You might be thinking that’s impossible, money doesn’t change price! It’s always worth exactly the same! Unfortunately, that’s just not how money works.
Money is assigned value based on its purchasing power, or the amount of things you can buy with that money.
Let’s take the example of coffee using U.S. currency. In 1970, most restaurants charged 25 cents for a cup of coffee. That meant that your dollar was worth about four cups of coffee. Then, the economy changed. As a result,
- Unemployment went up, then down, then back up again
- Global supply and demand chains shrank and then exploded
- Countries entered recessions, then hit huge periods of prosperity and wealth, and then came the pandemic
- Countries across the world struggled with the financial impact of the pandemic on major sectors of their economy
- Jobs, business, and stock markets suffered as a result
All of those global changes had an impact on the value of money. As time passed, people began charging more in order to survive hard economic periods. The more people charged, the more others worked in order to pay for their lifestyles, and the more money people earned. The more money people earned, the more people raised the price of goods and services to match the higher incomes of their clients, and the cycle repeated itself all over again.
The process of adjusting wages, the cost of goods and services, and cost of living in response to economic influences is what causes inflation. Today, that same cup of coffee that once cost 25 cents will now cost you $1.60 or more. The American dollar has inflated by 581% in the last fifty years, meaning that $100 then is equivalent to $681 dollars now.
You might be thinking, hey, more money for me, right? But as we know, the economy is interconnected, and an increase in one place is almost certainly tied to a decrease somewhere else.
What is Deflation?
Deflation is the opposite economic process of inflation. If inflation is associated with more jobs, more money, and higher priced goods and services, then deflation is a time of high unemployment, less money for people, and lower prices for items. Deflation increases the value of money because there’s less money to go around: your money buys more items because everything is selling for less money than it normally would.
What’s the problem with inflation?
Rising inflation distorts the price of goods and services and devalues wages. It causes an increase in cost of living that can’t always match pace with the wages that people are making. The pandemic has been an excellent example of that. In the beginning of the pandemic, governments across the world were struggling to match the need of their citizens for financial help and support. Some turned to stimulus programs or distributions to try and make ends meet. However, the increase in the supply of money triggered inflation. Because more people had money, basic things like groceries and household essentials began to cost more. That money didn’t stretch as far because everything else began to cost more.
Luckily, many countries took swift action to try and control inflation, slashing interest rates and taking other important financial measures to try and salvage their economy. Economists are still carefully watching to see what will happen next as economies slowly begin to reopen after the initial wave of shut-downs. Will inflation stabilize? Will it spike? Only time can tell.