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What is inflation? How does it affect money supply?

-by Adam Macneil

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Article: How Inflation Can Negatively Affect Money Supply

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Article: How Inflation Can Negatively Affect Money Supply

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This article talks about one of the most well-known economic collapses due to inflation in recent history. Following the first world war, Germany was forced to make reparations. In order to pay up to such a hefty fee, the government began to rapidly produce banknotes. However, its production and release could not match up to the country's production rate. Therefore, the economy collapsed, and money was worth virtually nothing. This is a prime example of what NOT to do in an economic crisis.

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It is not however the case that the economy within Germany continued to decline throughout the whole of the period 1919 - 1923. In 1920 the currency stabilized for a period of some 6 months. *The mark actually gained in value against foreign currencies, so that prices of imported goods (commodities) fell by some 50%.

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Video: The Effects of Inflation Over Time

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Video: The Effects of Inflation Over Time

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This video accurately explains the effects of inflation. As many people know, inflation rates cause the value of money to decrease over time. In this video, it is brought down to a small scale (the cost of a single burger) to make it easy to understand inflation growth. When this effect is reproduced with larger numbers, the reduction in a currency's worth is decreased significantly.

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This video describes how inflation affects our spending and savings.

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In 1923, a German woman is pictured burning money, as it is worth nothing in comparison to the cost for heating. This economic collapse is a prime example of hyperinflation.

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This article outlines the absolute worst cases of economic inflation over the past 100 years. I find that the most interesting part of this article is learning exactly HOW the economy crashed in each scenario. It is almost always due to exterior sources, war, or corruption. Looking at the trend, the effects of rapid inflation usually only lasts a few years. During this time, however, the population struggled immensely to adapt. To me, it is compelling to know the causes behind each of the collapses, and how our modern government can behave in order to avoid them.

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I have a neat little app on my smartphone that I like to look at when I'm feeling bored. It won't change anything in my life, but it makes me think as I see the numbers clocking up, and then suddenly stopping for a few seconds. It's the app that tells me the how much the National Debt of each country stands at in real-time. As I sit down at my computer screen the USA National Debt amounts to $17 041 241 xxx xxx. Forgive the x's...they're not kisses...I tried to get the last six digits, but, there's no point, they're moving too fast! Speedie Gonzalez has got into that app! It works out to $54 087 per person. That's the same value as 3 408 248 816 XXX Big Mac Meals.

Inflation is hot property today, hyperinflation is even hotter! We think we are modern, contemporary, smart and ready to deal with anything. We've got that seen-it-all-before, been-there-done-it attitude. But, we are not a patch on what some countries have been through in the worst cases of hyperinflation in history. Here's the top 10 list of worst cases in history. We'll start with the worst first...let's think positive!
1. Hungary 1946
Inflation at its peak reached a staggering figure of 13.6 quadrillion % per month! That's 13, 600, 000, 000, 000, 000%. The largest denomination bill was a 100 Quintillion note. Prices ended up doubling every 15 hours at the time.
2. Zimbabwe 2008
Prices doubled here every 24.7 hours in November 2008 and inflation reached levels of 79 billion-odd %. They eventually stopped using the official currency and switched to the South African Rand or the $US. A loaf of bread ended up costing $35 million. This is the most recent case. It was Mugabe's land-redistribution program that caused this.
3. Yugoslavia 1994
In just the one month of January 1994 inflation rose by 313 million %. Prices doubled every 34 hours (which is nothing compared to Hungary). The currency ended up getting revalued 5 times in all between 1993 and 1995, all to no avail. The cause? A recession triggered by overseas borrowing and an on-going political struggle in the 1980s and the following decade.
4. Germany 1923
Adolf Hitler rose to power as a consequence of hyperinflationary pressure (at least one of the reasons). Prices doubled every 3.7 days and inflation stood at 29, 500%. Germany was crippled with the reparation payments after the Treaty of Versailles and the end of World War I.
5. Greece 1944
Prices started rising by 13, 800% in October 1944 and they doubled every 4.3 days. The trouble was the debt incurred by World War II.
6. Poland 1921
Prices rose in 1921 by 251 times in comparison with those of 1914. They doubled every 19.5 days. The Zloty was introduced as the new currency in 1924 in an attempt to start afresh. Inflation stood at 988, 233% in 1924.
7. Mexico 1982
Mexico had a rate of inflation of 10, 000% in 1982 (due mainly to too much social expenditure).
8. Brazil 1994
Inflation was 2, 075.8% at its worst in 1994. The Real was adopted in 1994 and it managed to calm inflation down.
9. Argentina 1981
The highest denomination bill was the one million pesos note. The Peso was revalued three times.
10. Taiwan 1949
This was a knock-on effect from China and the Chinese Civil War. The New Taiwan Dollar was issued in June 1949. The monthly rate of inflation stood at 399%

Inflation can be creeping (mild or moderate inflation) or galloping. We can talk of Hyperinflation and stagflation (inflation and recession). Deflation is not better. We have so many names for it.

Hyperinflation means prices doubling in such a short space of time that we can't keep up with it all. Hyperinflation comes about at times of trouble, war, conflict, upheaval, change on unprecedented levels. It comes about because we still haven't learnt how to control it. History repeats itself, we hear people say. Thankfully, it doesn't repeat itself too often. Fingers crossed.

But, in the time it took for me to write this, the US National Debt is now worth $17 041 308 85xx xxx, that means 3 408 261 915 xxx Big Mac Meals!

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Hyperinflation - 10 Worst Cases - ToTheTick™

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I have a neat little app on my smartphone that I like to look at when I'm feeling bored. It won't change anything in my life, but it makes me think as I see the numbers clocking up, and then suddenly stopping for a few seconds.

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This video gives an in-depth definition of economic inflation. It touches on some of the pictures and articles mentioned in this padlet. As it is mentioned in this video, inflation can best be described as "too much money chasing too few goods". As it turns out, having enormous amounts of life savings can quickly become worthless. If the production of goods and services is matched with the purchases of the people, then inflation should be reduced. However, if a country's production and money creation do not match, then the cash ends up floating and becoming less and less valued.

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This picture touches on the important fact that the economy must always learn and adapt from the constant effect of inflation. The production of goods and the creation of money must always be balanced.

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While this comic is a bit exaggerated, it does still have an important meaning behind it. If we are not aware of the constant increase of inflation around us, then we cannot be prepared for the future. Economic inflation may be gradual, but it still has a solid impact over time, which can be especially damaging when large sums of money are on the line.

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This video clearly defines the difference between regular, scheduled inflation and rapid inflation. As it turns out, inflation is a normal practice that the economy must undergo in order to keep things running smoothly. Inflation not only affects the common person, but also has a heavy influence on private corporations such as banks. In order to keep up with inflation, they, along with every other business has to make economic changes in order to keep up with the constant change. This results in banks giving out hefty loans, making it harder to save money. The best way to keep up with this increase is to make a separate savings account that keeps up with the change in economic inflation.

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This article explains in detail what it means to have inflation, as well as what the government should be doing to control it. Some of the methods are historically proved to work flawlessly, while others have no choice but to launch the country into a recession. For example, one of the most popular methods of controlling inflation is to hike the prices of wages and necessary payments in order to balance the economy. While this method can work in the long run, the immediate effects can be damaging. If the government isn't careful, it can result in a mass loss of jobs. In reading this article, I have learned that reduced spending is directly linked to inflation growth. If the economy is halted, then so is inflation growth.

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Inflation occurs when an economy grows due to increased spending without an accompanying increase in the production of goods and services. When this happens, prices rise and the currency within the economy is worth less than it was before. The currency essentially won't buy as much as it would before.

When a currency is worth less, its exchange rate weakens when compared to other currencies. However, this depends on whether other countries are inflating less than yours. If they are inflating faster than your country, your currency might strengthen, which is a basic purchasing power parity argument.

There are many methods used to control inflation; some work well, while others may have damaging effects. For example, controlling inflation through wage and price controls can cause a recession and cause job losses.

Contractionary Monetary Policy

One popular method of controlling inflation is through a contractionary monetary policy. The goal of a contractionary policy is to reduce the money supply within an economy by decreasing bond prices and increasing interest rates.

This helps reduce spending because when there is less money to go around: those who have money want to keep it and save it, instead of spending it. It also means there is less available credit, which can reduce spending. Reducing spending is important during inflation because it helps halt economic growth and, in turn, the rate of inflation.

Federal Funds Rate

There are three main tools to carry out a contractionary policy. The first is to increase interest rates through the central bank. In the case of the U.S., that's the Federal Reserve. The Fed Funds Rate is the rate at which banks borrow money from the government, but in order to make money, they must lend it at higher rates.

When the Federal Reserve increases its interest rate, banks then have no choice but to increase their rates as well. When banks increase their rates, fewer people want to borrow money because it costs more to do so while that money accrues at a higher interest. So spending drops, prices drop and inflation slows.

Reserve Requirements

The second tool is to increase reserve requirements on the amount of money banks are legally required to keep on hand to cover withdrawals. The more money banks are required to hold back, the less they have to lend to consumers. If they have less to lend, consumers will borrow less, which will decrease spending.

Reducing the Money Supply

The third method is to directly or indirectly reduce the money supply by enacting policies that encourage the reduction of the money supply. Two examples of this include calling in debts that are owed to the government and increasing the interest paid on bonds so that more investors will buy them.

The latter policy raises the exchange rate of the currency due to higher demand (through capital inflows if your rates are increasing relative to foreign rates) and, in turn, increases imports and decreases exports. Both of these policies will reduce the amount of money in circulation because the money will be going from banks, companies and investors' pockets and into the government's pocket where it can control what happens to it.

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What Methods Do Governments Use to Fight Inflation?

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Inflation occurs when an economy grows due to increased spending without an accompanying increase in the production of goods and services. When this happens, prices rise and the currency within the economy is worth less than it was before. The currency essentially won't buy as much as it would before.