Inflation simply explained

What is Inflation

Inflation describes the general increase in the price level within an economy and the resulting devaluation of money. Simply put, this means that the purchasing power of money decreases. Thus, the population can buy less with the same amount of money. Inflation is also an important indicator of the health of an economy. It is important to note that inflation is only spoken of when the average price of a variety of goods increases. If, for example, bread becomes more expensive temporarily, this is not yet inflation.

How is Inflation Created?

Inflation can have a variety of causes. Here are the two most important ones:

Firstly, a lack of supply or excessive demand for a necessary commodity such as gasoline, electricity, or grain can increase inflation. Since it is not possible to simply do without electricity or food, the population has to pay the price, willing or not. Thus, less money flows into other areas of the economy, such as luxury goods or tourism, since the population simply can no longer afford them.

Also, an increase in the general money supply can be a reason for inflation. This happens when the national bank or the central bank excessively increases the money supply without it being balanced by a corresponding increase in production or income. The best example of such drastic devaluation of money was seen in Germany shortly after World War I.

How is Inflation Calculated?

Normally, inflation is measured using a virtual basket of goods. The basket represents a variety of goods and services that are purchased by an average household, such as food, transportation, and medical costs.

To calculate inflation, the prices from the basket are evaluated at regular intervals and compared with previous periods. The percentage difference can be calculated based on the price difference.

An example:

Let's assume the basket has a price of Fr. 100 in January 2022 and Fr. 104 in January 2023. The inflation rate is therefore 4%. This means that the general price level in January 2023 has risen by 4% compared to January 2022.

However, it should be mentioned that most countries aim for an inflation rate of around 2% per year, as this value indicates healthy economic growth.

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