Inflation, as commonly known, is the government printing an excess amount of money. But why does that matter?
Printing more money decreases the value of the currency itself. As more money is printed, the interest rate decreases, causing businesses and individuals to take more loans. When businesses take more loans, they invest more in their product and pay workers higher incomes. When individuals take loans, they spend more money and that money eventually ends up in the pockets of businesses. Businesses again end up increasing their worker’s wages either through investment or from increased profit. In summary, the government’s printing money increases income throughout society. Although that sounds great, it comes with severe consequences.
When individual households and businesses have less money overall, it decreases the value of each individual unit of currency. For example, if Person A’s income was $1,000 per month before inflation and $15,000 after inflation, losing some money would worry Person A more before inflation than after inflation. For example, in Germany after World War I ended (the early 1900s), hyperinflation, or an extreme form of inflation, left people burning money instead of wood in their fireplaces because the value of their currency had dropped so much. A decrease in the value of currency has a few consequences:
When the value of money overall decreases, so does the money saved by individuals. If savings constantly keep decreasing in value, individuals get discouraged and stop saving as much as they did before. This is especially a problem for the middle and lower class who save more money than they would have otherwise used to buy a necessity. Without savings, any sudden expenditure (e.g. accident) would cause these families to take loans and incur further into debt.
Although this issue isn’t nearly as devastating as the one above, “menu costs” are still a negative consequence of inflation. To deal with the decreased value of currency, businesses have to constantly change their product prices to ensure they are not losing potential income. This includes changing price displays, re-editing advertisements, calculating the new optimal pricing, and more. “Menu costs” force businesses, especially smaller ones, to spend much more money than they initially would have which may contribute to a decrease in economic growth.
Because of its many negative consequences, inflation is an important thing for governments to keep check on, especially governments of developing countries.