Inflation. A word that we commonly hear in the news, read in the newspaper but never really grasp the idea of what it really is. Many Malaysians of my age, we probably heard it first when we were around 11 year old, standard 5. that year was 1998, when Malaysia was hit hard by the Asian Economic Crisis. Our former Prime Minister Mahathir implemented Zero Inflation measure, which was believed to be the ideal economic measure at that time (Which of course modern economist now would disagree with this method).
If we were asked whether we know what inflation is, we probably will say that we know of it. Of course, we hear about it all the time now right?? But then again we can't really describe what it actually is, how it happens and how it really affects us in a bigger picture. Yeap, we are that ignorant, even though this percentage affects us in so many ways in our life. Why bother when we can just blame it all on the economists and the politicians right?
In the not so modern world, but not really ancient, somewhere in the 18th century, economists said that inflation is the decrease in the value of a currency. In Layman term, If in year 1800 you can buy a pair of shoes for $1, in the year 1801 the same pair of shoes gonna cost you $1.50. That means your currency value diluted and you needed more of the currency to buy the same stuff. This is mainly caused by the supply of currency is bigger than the demand in the market. Too much currency(or fiat money in our case now) is being injected into the monetary system.
However in the modern world nowadays, especially when the world has gone through the industrialization era, economists realized that inflation does not just got affected by the supply of currency itself, but also the supply of the goods or commodities in the market. Example, if the supply of shoes suddenly quadrupled in the year 1801, the same pair of shoes probably gonna cost less than $1 compared to the previous year. It would probably be $0.50. In this case, your currency value has increased because the same $1 can buy you 2 pair of shoes in a year gap. So the supply of goods and the supply of currency, they both play their roles to determine the value of your currency.
Some people came to me and said that inflation would not happened if we stopped using fiat money and use gold or silver as currency. WRONG! 2 examples. When Europe was in their expansion and colonization era, Spain had a serious inflation issue when their conquistadors from the South America started bringing home all the gold from the Aztecs civilization that they plundered. The sudden influx of gold has eroded gold's value, because everyone suddenly had so many gold to spend. The other example was, even gold coins in the old days used to be circulated in a way where they would be collected, melted, and then mixed with other metals such as silver or iron etc. 300 gold coins came in, 1000 "not 100% gold" coins came out. 300 gold coins went back to the people, 700 would be used by kings and governments to fund their wars. Pretty good war funding machine this inflation thing was, and still is.
That is why there are these terms "nominal" and "real" when financial people talk about investments or loans. Nominal is the percentage, gain or loss without factoring in the inflation rate, whereas real is the percentage when you factor in inflation rate. Example, if your salary increment last year was 3%, and the Malaysia average annual inflation rate is 3%, your nominal increment is 3%, but your real increment is actually 0%. Because your new salary actually has exactly the same purchase power of your old salary. If your increment is actually lower than the inflation rate, well, you're kinda got screwed. At the same time, Corporations and employers have been using inflation as a tool to cut your "real" salary without you even realizing it. They get to sell their goods at higher price due to inflation, but giving you sub inflation increment gives them bigger margin on their profit. Sneaky yeah?
Deflation
Now you pretty much understand that excess supply of money can cause inflation right? And you would have this idea in mind "Why don't the government stop printing money like mad and curb this inflation issue" US government probably has been quite infamous recently with their currency printing stimulus program, at the same time diluting their USD currency value. Let me introduce you to the other side of inflation, the dark side of inflation. Deflation. It is when inflation has negative value. So it works the other around. But it may sounds good at first, because unlike inflation, the value of your currency increases over time. Your purchasing power increases. But not good in a bigger picture.
Japan is an example of a country that has been battling deflation for decades. In the 80s when their economy was booming, productivity increased like mad in Japan, a lot of goods and products need to be moved and sold, but the currency supply did not increased at the same pace with their productivity. Add in the baby booming factor into the equation, you imagine a country with the same amount of money in circulation, but the population grew exponentially, and the goods and products also increased at the same time. Day by day, people realized that the currency they hold is increasing in value due to lack of supply, whereas the value of goods are decreasing because of oversupply. This will discourage people to spend or invest their money. This situation is called liquidity trap where money is being trapped, hoarded, and not circulated, which further worsen the situation of the lack supply of money.
Corporations will make less profit in this case, since income has been reduced due to lack of sales and lowered price because of oversupply. They can't use the cut "real" salary method, because there is no inflation in this case. The value of money is stronger over time. So even if they give you 0% increment, the nominal increment is 0% but you are getting a "real" increment, because the value of money increases. So there is no other method but to cut manpower or stop hiring, or just cut your salary period. Unemployment rate will rise, the cycle will continue. Deflation is considered a vicious cycle because it is very tough to get out of it. Go ask Abe, he is still struggling to bring Japan out of it and his over-hyped Abenomics doesn't do jack. He tried using US formula, introducing money stimulus, printing out Japanese Yen. Japanese corporations have been making billions of yen out of the program, but the corporations still refused to flow down the wealth down to the people. Theoretically, the corporations that benefited from this program should then give out more salary increment to their employees so that the money will move, generate the economy, and bring out all the hoarded money. But the corporations themselves are still afraid to spend and hoarding the money for themselves. Stingy bunch if you ask me.
Hyper-inflation
There is another version of inflation. Hyper-inflation. I think many of you probably have heard a story about how inflation gone on total rampage like nobody business. Zimbabwe. If you read in google, somewhere in 2008, the inflation rate of Zimbabwe was estimated to be 6.5sextillion percent. Haha did you read that, sextillion!! I didn't even know that word exist before I read about that article. If I were to write the number down, I probably had to spend like a few minutes to write the number down, and recount whether I had the right number of zeros. Basically the causes can be simplified to no regulations, printing money to fund war, and corruption. No need to write in further details.
Needless to say, this situation is very bad since the money you hold pretty much worth nothing. $10 Zimbabwe dollar would worth nothing if the biggest note that they printed out was $100billion. You would think that this kind of thing would only happened to 3rd world country like Zimbabwe, but Germany themselves have had some series of hyperinflation drama with their Mark. Go google for more details.
The conclusion, inflation is an economic tool which has to be used very diligently. It is hard to pinpoint what is the ideal inflation rate, because every country has a different situation economic background, but many economists nowadays agree that 2% range is the ideal number to promote economic growth without eroding too much purchasing power from the people. Really need some extraordinary minds and leadership to dictate a country's economic move. May Malaysia be blessed with those people.
I myself am still learning about these things and may have different or wrong understanding about this whole thing. After all, I'm just a Chemical Engineering student, never have touched any economic textbooks my whole student life. If there are any wrongs in my writing, or anything that I misunderstood, please let me know or drop a comment. Or if you would like to have a cuppa to discuss about these kind of things, I am more than pleased to do so. I always have time to learn about these subjects that I missed when I was in school.
Farouk
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