Carol Faulkner, age 13, of Tacoma, Wash., for her question:
CAN YOU EXPLAIN INFLATION?
In economics, inflation is a term used to describe a decline in the value of money. Inflation is the sustained rise in the aggregate level of prices measured by an index of the cost of various goods and services.
With inflation, repetitive price increases erode the purchasing power of money and other financial assets with fixed values, creating serious economic distortions and uncertainty.
Inflation results when actual economic pressures and anticipation of future developments cause the demand for goods and services to exceed the supply available at existing prices or when available output is restricted by faltering productivity and marketplace constraints.
Sustained price increases were historically considered an aberration directly linked to wars, poor harvests, political upheavals or other unique events.
On the other side of the economic coin is deflation. This condition involves a sustained decline in the aggregate level of prices, such as occurred during the Great Depression of the 1930s. Deflation is usually associated with a prolonged erosion of economic activity and high unemployment.
Widespread price declines have become rare, however, and inflation is now the dominant variable affecting public and private economic planning.
When the upward trend of prices is gradual and irregular, averaging only a few percentage points each year, such creeping inflation is not considered a serious threat to economic and social progress. It may even stimulate economic activity.
A greater concern is the growing pattern of chronic inflation characterized by much higher price increases, at annual rates of 10 to 30 percent in some industrial nations and even 100 percent in some developing nations. Chronic inflation tends to become permanent and goes upward to even higher levels as economic distortions and negative expectations accumulate.
Normal economic activities are disrupted to accommodate chronic inflation. Consumers buy goods and services to avoid even higher prices. Real estate speculation increases. Businesses concentrate on short term investments. Long term bonds, pensions, incentives to acquire savings and insurance policies are reduced because inflation erodes their future purchasing power.
With chronic inflation governments rapidly expand spending in anticipation of inflated revenues and exporting nations suffer competitive trade disadvantages forcing them to turn to protectionism and arbitrary currency controls.
In the most extreme form, chronic price inflation becomes hyperinflation, causing the entire economic system to break down.
Hyperinflation occurred in Germany following World War I. It caused the volume of currency in circulation to expand more than 7 billion times and prices to jump 10 billion times during a 16 month period