Economic's Terms

Economists use the term “inflation” to denote an ongoing rise in the general level of prices quoted in units of money. The magnitude of inflation—the inflation rate—is usually reported as the annualized percentage growth of some broad index of money prices. With U.S. dollar prices rising, a one-dollar bill buys less each year. Inflation thus means an ongoing fall in the overall purchasing power of the monetary unit.

Inflation rates vary from year to year and from currency to currency. Since 1950, the U.S. dollar inflation rate, as measured by the December-to-December change in the U.S. Consumer Price Index (CPI), has ranged from a low of −0.7 percent (1954) to a high of 13.3 percent (1979). Since 1991, the rate has stayed between 1.6 percent and 3.3 percent per year. Since 1950 at least eighteen countries have experienced episodes of hyperinflation, in which the CPI inflation rate has soared above 50 percent per month. In recent years, Japan has experienced negative inflation, or “deflation,” of around 1 percent per year, as measured by the Japanese CPI. Central banks in most countries today profess concern with keeping inflation low but positive. Some specify a target range for the inflation rate, typically 1–3 percent.

Although economies on silver and gold standards sometimes experienced inflation, inflation rates in such economies seldom exceeded 2 percent per year, and the overall experience over the centuries was inflation of close to zero. Economies on paper-money standards, which all economies have today, have displayed much more inflation. As Peter Bernholz (2003, p. 1) points out, “the worst excesses of inflation occurred only in the 20th century” in countries where metallic standards were no longer in force. In 1971 the U.S. government cut the U.S. dollar’s last link to gold, ending its commitment to redeem dollars for gold at a fixed rate for foreign central banks. Even among countries that have avoided hyperinflation, inflation rates have generally...