What Is Inflation? A Youth Finance Guide

Age group: 12-18 years old

Have you ever heard a group of people complaining about how the price of everything is going up? Maybe you’ve noticed that your favorite snacks, video games, or subscriptions all seem to cost a bit more than they used to. The cause might be inflation — let’s find out!

What Is Inflation?

Inflation happens when the price of everything goes up — sometimes way up. This increase is expressed as a percentage called the inflation rate.

Inflation and Purchasing Power

Purchasing power is a phrase used to describe how much your money can buy. When inflation happens, your money suddenly has less purchasing power because you have to spend more money to buy the same things you were buying before.

Try it out!

Want to see how purchasing power has changed over time? You can with the Department of Labor’s inflation calculator!

Is It Inflation?

Prices can go up for many reasons besides inflation. For instance:

• A clothing brand suddenly becomes popular and costs more because more people want to buy it.
• Weather conditions aren’t right, and fewer peaches grow this year, so peaches cost more than usual.

But in these cases, the higher price is temporary and only affects a few products.

Inflation affects the cost of many different products at the same time. Also, while prices might go down once inflation passes, they usually don’t go down to their pre-inflation prices. That’s why most things cost more now than when your parents and grandparents were young.

What Causes Inflation?

The physical money people use to pay for things in an economy is called currency in circulation. It’s all the money that the government has made available for citizens to use to buy things, make things, or pay workers.

Inflation happens when the currency in circulation increases faster than the economy can produce things to buy. In this situation, people tend to have more money to spend, but because there’s lots of money around, their money has less value.

But why is there sometimes more money available in an economy?

Government Intervention

Governments try to manage their economies to keep them healthy and growing. They control economies by changing the amount of currency in circulation, interest rates, and the types and amounts of taxes collected. However, sometimes these actions can cause inflation.

Higher Cost of Production

Inflation also rises when it costs more to make goods. Production costs could rise if workers’ wages rise or because of supply shocks. These are events like natural disasters, wars, or pandemics that prevent us from getting the materials we need to make products.

Decline in Productivity

When productivity drops, this creates shortages of goods. Productivity might drop for reasons like a worker shortage or lack of demand.

Types of Inflation

There are two main types of inflation. While their causes are different, both have the same effect: money loses purchasing power.

Demand-Pull Inflation

Demand-pull inflation happens when people want to buy more products than their country can produce. In this situation, people have money they want to spend but can’t get the things they want to spend it on. As a result, the few sellers who have products raise their prices.

One example of demand-pull inflation happened after the COVID-19 pandemic in 2020. Once people could leave their homes again, so many people decided to travel that airlines didn’t have enough seats on flights for everyone. That allowed airlines to charge more for each ticket they sold.

Cost-Push Inflation

Cost-push inflation happens when it costs more to make a product, so the price of the product increases. If a product costs more to make, then the person or company making it has to either make less money on the product or raise the price of the good to keep making a profit.

An example of cost-push inflation happened in 2005 when Hurricane Katrina struck the southeastern United States. The storm severely damaged major oil refineries that were producing gasoline. The price of gas soared as oil companies tried to rebuild their refineries.

When Has Inflation Happened?

Analysts at the U.S. Bureau of Labor Statistics gathers data each year on the costs of common household goods in the United States. They include costs such as housing, groceries, and utilities to calculate the consumer price index (CPI). Comparing the CPI from one year to the next helps them determine the inflation rate.

The inflation rate soared to over 20% after World War II. During the war, factories were producing goods for the war instead of goods for people’s homes. With fewer products to buy, people saved their money. This extra cash combined with a shortage of products meant prices skyrocketed until factories could be refitted to make new products.

Test Your Knowledge

What kind of inflation happened after World War II — demand-pull or cost-push?

The longest period of inflation in U.S. history happened during the 1970s. Conflict with oil-producing countries in the Middle East led to an embargo, or one country refusing to trade with another. Then wars in Iran and Iraq slowed oil production and made it difficult to get oil to the United States, leading to gas shortages and high prices.

Test Your Knowledge

What kind of inflation happened during the 1970s — demand-pull or cost-push?

Is Inflation Good or Bad?

Inflation is like Goldilocks’ testing the hardness of different beds in “Goldilocks and the Three Bears.” You want some, but not too much. When the inflation rate is just right, it helps everyone.

How can inflation help people? When there’s more currency in circulation, it means that people have jobs, and that people are more likely to buy products. That creates a demand for more production, and production creates even more jobs for the people who make and sell products. In this way, inflation can help propel a cycle of earning and spending.

How can inflation help people? When there’s more currency in circulation, it means that people have jobs, and that people are more likely to buy products. That creates a demand for more production, and production creates even more jobs for the people who make and sell products. In this way, inflation can help propel a cycle of earning and spending.

Pro Tip

The Federal Reserve tries to keep the U.S. inflation rate at 2%. Do you know what the inflation rate is today?

The Takeaway

Monitoring inflation is an important way of tracking the health of a country’s economy. Understanding the forces that influence inflation and how it affects you can help you make better choices and stretch your dollars a little further.