In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys services; the measure of inflation is the inflation rate, the annualized percentage change in a general price index the consumer price index, over time. The opposite of inflation is deflation. Inflation affects economies in various negative ways; the negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include reducing unemployment due to nominal wage rigidity, allowing the central bank more leeway in carrying out monetary policy, encouraging loans and investment instead of money hoarding, avoiding the inefficiencies associated with deflation.
Economists believe that the high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth. Today, most economists favor a steady rate of inflation. Low inflation reduces the severity of economic recessions by enabling the labor market to adjust more in a downturn, reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy; the task of keeping the rate of inflation low and stable is given to monetary authorities. These monetary authorities are the central banks that control monetary policy through the setting of interest rates, through open market operations, through the setting of banking reserve requirements.
Rapid increases in the quantity of money or in the overall money supply have occurred in many different societies throughout history, changing with different forms of money used. For instance, when gold was used as currency, the government could collect gold coins, melt them down, mix them with other metals such as silver, copper, or lead, reissue them at the same nominal value. By diluting the gold with other metals, the government could issue more coins without increasing the amount of gold used to make them; when the cost of each coin is lowered in this way, the government profits from an increase in seigniorage. This practice would increase the money supply but at the same time the relative value of each coin would be lowered; as the relative value of the coins becomes lower, consumers would need to give more coins in exchange for the same goods and services as before. These goods and services would experience a price increase. Song Dynasty China introduced the practice of printing paper money to create fiat currency.
During the Mongol Yuan Dynasty, the government spent a great deal of money fighting costly wars, reacted by printing more money, leading to inflation. Fearing the inflation that plagued the Yuan dynasty, the Ming Dynasty rejected the use of paper money, reverted to using copper coins. Large infusions of gold or silver into an economy led to inflation. From the second half of the 15th century to the first half of the 17th, Western Europe experienced a major inflationary cycle referred to as the "price revolution", with prices on average rising sixfold over 150 years; this was caused by the sudden influx of gold and silver from the New World into Habsburg Spain. The silver spread throughout a cash-starved Europe and caused widespread inflation. Demographic factors contributed to upward pressure on prices, with European population growth after depopulation caused by the Black Death pandemic. By the nineteenth century, economists categorized three separate factors that cause a rise or fall in the price of goods: a change in the value or production costs of the good, a change in the price of money, a fluctuation in the commodity price of the metallic content in the currency, currency depreciation resulting from an increased supply of currency relative to the quantity of redeemable metal backing the currency.
Following the proliferation of private banknote currency printed during the American Civil War, the term "inflation" started to appear as a direct reference to the currency depreciation that occurred as the quantity of redeemable banknotes outstripped the quantity of metal available for their redemption. At that time, the term inflation referred to the devaluation of the currency, not to a rise in the price of goods; this relationship between the over-supply of banknotes and a resulting depreciation in their value was noted by earlier classical economists such as David Hume and David Ricardo, who would go on to examine and debate what effect a currency devaluation has on the price of goods. The adoption of fiat currency by many countries, from the 18th century onwards, made much larger variations in the supply of money possible. Rapid increases in the money supply have taken place a number of times in countries experiencing political crises, produ