What is inflation?
Inflation means that the general price level in an economy rises. This means that you can buy less with the same amount of money – the money loses value.
Individual price fluctuations are normal. However, we only speak of inflation when many prices rise simultaneously and permanently. The inflation rate shows the extent of inflation.
What types of inflation are there?
Inflation occurs in various forms and intensities. It can be categorized according to its speed and perceptibility. Each type of inflation has specific implications for companies and the economy as a whole.
Differentiation by speed
Creeping inflation
- Prices rise almost imperceptibly over time.
- The annual inflation rate is below 5 percent.
- Frequent cause: full employment. Strong purchasing power and willingness to buy motivate suppliers to raise prices.
Trotting inflation
- Inflation rate of more than 5 percent, in some cases as high as 10 percent
- Prices rise in a short time.
- The effects are clearly being felt by the population and social tensions are rising.
Galloping inflation
- Inflation rates are above 10 or 20 percent.
- Without rapid countermeasures, hyperinflation threatens with inflation rates of over 50 percent.
- The population tries to invest assets in foreign currencies or scarce, valuable substitute goods.
Differentiation according to perceptibility
Hidden inflation and back-loaded inflation
- Price increases are not openly visible.
- Signs include a shortage of goods, lower product quality or smaller packaging sizes.
- A related phenomenon is stalled inflation: price increases are suppressed by regulations, and prices only rise sharply after government intervention has ceased.
Open inflation
- Price increases are clearly visible and measurable.
- Prices for goods and services rise without government intervention or regulation.
- There are many reasons for this, such as increased demand or rising production costs.
Other important economic price dynamics
In addition to inflation, there are other price dynamics that influence the purchasing power of the population and the economic situation of national economies.
Deflation
Die Deflation beschreibt eine Phase anhaltender Preissenkungen in einer Volkswirtschaft. Das Phänomen ist seltener als eine Inflation. Hierbei ist die gesamtwirtschaftliche Nachfrage niedriger als das Gesamtangebot an Gütern, da zu wenig Geld in Umlauf ist. Die Folgen sind gravierend: Unternehmen senken aufgrund geringerer Gewinnerwartungen ihre Investitionen und reduzieren ihre Produktion durch Maßnahmen wie Kurzarbeit oder Standortschließungen. Das lässt wiederum die Arbeitslosigkeit steigen und führt zu Einkommensverlusten, einer schrumpfenden Nachfrage und sinkenden Steuereinnahmen.
Stagnation
In a phase of stagnation, the economy comes to a standstill. In contrast to inflation, the price level usually remains stable or moves only slightly. Companies are reluctant to invest and consumer demand is also weak. Stagnation can be both a cause and a consequence of other economic problems, such as structural weaknesses.
Stagflation
Stagflation is an economic phenomenon in which high inflation meets economic stagnation. This scenario is rare. As rising prices occur in parallel with high unemployment, it is particularly difficult to take effective economic policy countermeasures. This is because measures against inflation could exacerbate stagnation and vice versa.
How do you measure inflation?
Inflation describes the general increase in prices. How this is measured largely determines the level of the inflation rate.
As a rule, a price index is used, which is made up of prices for a wide range of goods and services that are representative of the economy and determine the cost of living for private households.
Germany
In Germany, the consumer price index (CPI) is used to calculate inflation. It measures the average price development in private household consumption every month. For this purpose, a fictitious basket of goods is filled with around 700 typical goods and services on which private households spend money. The types of goods are weighted and combined to form the consumer price index. The costs for such a fictitious basket of goods can be compared on a monthly and annual basis. Percentage deviations from previous measurement intervals indicate the inflation rate.
Europe
The European Central Bank (ECB) uses the Harmonized Index of Consumer Prices (HICP) to measure inflation. It is compiled by the statistical office of the European Union and, unlike the German basket of goods, contains 295 goods and services. It is used to calculate HICPs for each euro country and for the eurozone as a whole. As the national price indices are calculated using different methods, the ECB’s HICP enables comparability between countries.
Core inflation
In addition to inflation based on consumer price indices, core inflation is used as a further measure. Its basket of goods does not contain any volatile components such as energy and food. It is therefore better suited to analyzing long-term inflation trends and making monetary policy decisions on a stable basis.
4 typical causes of inflation
When inflation occurs, there is often not just one trigger. In most cases, a combination of different factors leads to sustained price increases. However, all causes have one thing in common: they lead to a disruption in the supply-demand balance.
Demand-induced inflation occurs when overall economic demand exceeds supply. This often occurs in phases of strong economic growth or following government economic stimulus programs or interest rate cuts. Companies react by raising prices in order to meet demand, which leads to an increase in the general price level.
Another form of inflation is cost-induced inflation. It is caused by rising production costs. Higher prices for raw materials, energy or labor are passed on to consumers by companies in the form of price increases. Such cost increases can be caused by external factors such as geopolitical conflicts, natural disasters or trade restrictions.
Imported inflation also plays a role. Price increases abroad, for example for raw materials or primary products, are transferred to the domestic economy via trade channels. Exchange rate fluctuations, such as a devaluation of one’s own currency, can further intensify these effects.
Finally, inflation can occur if the central bank increases the money supply faster than the economy grows(money supply-induced inflation). If more money meets the same amount of goods, sooner or later the price level will rise. This form of inflation is often the result of an expansionary monetary policy, for example to finance government spending.
What are the consequences of inflation?
Inflation has a profound impact on companies, consumers and the economy as a whole. Governments and central banks therefore often intervene quickly to combat inflation through monetary and fiscal policy measures. The aim is to restore price stability and economic equilibrium.
Effects on companies
Companies are feeling the effects of inflation through rising production costs, for example for raw materials, energy or wages. In order to secure their margins, they have to increase prices, but risk losing customers in the process. At the same time, uncertainty about how costs will develop in the future makes long-term planning difficult. As a result, investments usually decline during periods of inflation.
Inflation is particularly problematic for sectors with fixed contracts or long production cycles: in these cases, companies can only react slowly to price changes and are particularly affected by currency devaluation.
However, moderate inflation offers advantages for companies, as debts can be serviced more easily thanks to higher revenues. The more flexibly companies organize themselves and the better they can adapt to changing market conditions, the more competitive they remain – even during periods of inflation.
Effects on consumers
For consumers, inflation means a loss of purchasing power, as goods and services become more expensive while wages and salaries often rise more slowly. Many people postpone major purchases and forego buying luxury goods.
Inflation hits low-income households particularly hard, as essential expenses such as food, energy and rent make up a large proportion of their budget.
Another consequence of inflation is an increase in debt: consumers are increasingly using credit to maintain their standard of living. Inflation therefore not only changes consumer habits, but also increases social inequalities within society.
Effects on the national economy
At an economic level, inflation means a loss of price stability. Although moderate inflation can promote economic growth, high inflation increases uncertainty. Rising product prices reduce the competitiveness of exports. At the same time, savings are devalued, while real assets and shares increase in value. An unfavorable combination that stands in the way of economic growth.
In the long term, high inflation lowers the confidence of citizens and companies in their currency, which can jeopardize the stability of the entire economy.
Politics and central banks: how they fight inflation
Governments have various Fiscal policy measures available to curb inflation. They can raise taxes to reduce consumer demand or reduce government spending to calm demand in the economy.
Subsidies for certain goods such as energy can alleviate the immediate burden on consumers, while investments in infrastructure and innovation promote long-term stability. It is important to use measures in a targeted manner and adapt them flexibly in order to avoid economic imbalances and at the same time cushion social hardship.
Central banks use monetary policy instruments to curb inflation. Their main instrument is the regulation of the key interest rate. If it is increased, loans become more expensive and demand falls. In order to control the amount of money in circulation, central banks can sell government bonds(open market operations). In addition, a tighter minimum reserve policy can further restrict bank lending. All of these measures have an indirect effect on the economy by slowing down growth and stabilizing price levels.
How companies reduce damage caused by inflation
Companies can cushion the effects of inflation by adapting their strategies in a targeted manner and relying on modern technologies. The focus is on cost management and increasing efficiency.
When prices skyrocket, it is important to optimize production processes and diversify supply chains in order to reduce cost increases. Companies should also adjust their prices flexibly to market conditions in order to secure their margins. Last but not least, investments in tangible assets such as real estate or machinery can help to preserve the value of capital.
Bei der Umsetzung der Maßnahmen spielen digitale Technologien, wie Big Data Analytics, künstliche Intelligenz und ERP-Systeme, eine Schlüsselrolle. Denn sie bieten die Möglichkeit, in Echtzeit Daten zu analysieren und trotz inflationsbedingter Unsicherheit fundierte Entscheidungen zu treffen.
ERP-Systeme unterstützen beispielsweise bei der Überwachung von Rohstoffkosten, der Steuerung von Lagerbeständen und der Optimierung der Logistik. ERP-Systeme ermöglichen die Automatisierung diverser Prozesse, nicht nur in der Produktion. Damit sinkt die Zahl manueller Fehler radikal und es lassen sich massive Effizienzsteigerungen erreichen. Gleichzeitig können Unternehmen mithilfe der Daten aus ihrem ERP-System Kostenstrukturen genau nachvollziehen und Preise leicht anpassen. Kommt künstliche Intelligenz zum Einsatz, profitieren sie dabei von besonderer Weitsicht (Predictive Analytics).
The use of modern software is crucial for companies to remain competitive in times of inflation, to minimize economic damage and, in the best case, even to set themselves apart from the competition.
Conclusion and outlook
Inflation is a complex phenomenon with far-reaching effects on the economy and society. While moderate inflation can promote economic growth, high or uncontrolled price increases pose a considerable challenge. Causes such as excess demand, rising production costs or global conflicts make it clear how complex the dynamics of inflation are.
In the future, inflation could occur more frequently and last longer. This is because geopolitical tensions and global crises such as the energy transition and raw material shortages, as well as approaches to deglobalizing supply chains, harbour the potential for drastic price increases. Irrespective of this, companies have already been facing increased economic uncertainty for several years. It is therefore essential for them to drive forward their digital transformation in order to improve their resilience. After all, only with modern digital solutions can market changes be anticipated, strategy adjustments implemented quickly and decision-making certainty gained in uncertain times.
