In short inflation means an increase in the amount of money in circulation and the associated rise in price levels, while the total quantity of goods in the economy remains the same.
In general, inflation is best measured by a price index that reflects the increased price level, such as the consumer price index in Germany. The percentage increase in the price index over a given time frame is called the inflation rate.
When the total supply of goods is matched by an inflated money supply, the condition of inflation is fulfilled. If the total supply of goods cannot be increased in the short run, rising prices are the result, and inflation occurs. The price increases can trigger rising wages, which leads to rising costs for businesses. These rising costs, in turn, trigger price increases for goods. Price inflation is again amplified by rising demand. The wage-price spiral begins to spin and accelerate. In such a wage-price spiral, consumers tend to spend their money as quickly as possible before new price increases lead to further losses in purchasing power. There is a concomitant run into material assets.
Inflation also leads to a devaluation of savings so that the population’s inclination to save decreases. This behaviour restricts the ability of banks to grant loans to companies to finance investments. Consequently, production restrictions and thus higher unemployment can be the result.
Groups of people particularly affected by inflation are those who cannot adjust their income to rising prices, such as pensioners and the unemployed. Therefore, fighting inflation is an important goal of any economic and social policy.
Thus, price stability is the supporting pillar of functioning markets. It is the prerequisite for the functioning of the price mechanism and, therefore, crucial for economic growth and a high level of employment.