The Disadvantages of Inflation Rate

The major disadvantage of the inflation rate is the fact that it represents the lowering of money's value. This means that inflation rates represent a cut in everybody's net worth every year that they occur, which is most years.

However, there are degrees of inflation, with similar degrees of disadvantage. Standard inflation can generally be anticipated and compensated for. However, other forms cannot and have worse consequences.

General Inflation

In general, inflation is the lowering of money's value over time. The disadvantage of this is that it takes more money from one year to the next to buy the same amount of goods. This means that if a laptop costs $1,000 in 2010, and the inflation rate for that year is 3 percent, then it will probably cost around $1,030 the following year. The laptop has not gotten more valuable over time--the dollar has simply become less valuable.

Another reason this is disadvantageous is because it is a hidden cost. So, if you invest your money in a savings account that pays 4 percent interest each year, and the inflation rate is 3 percent, you are actually only making 1 percent on your investment--a 4 percent increase minus a 3 percent decrease in value.

Hyperinflation

Hyperinflation is very rapid inflation. Hyperinflation occurs when the supply of currency is profoundly higher than the demand for it, which is caused by a rapidly deteriorating economy or rapid printing of money by the government. One of the best examples of this is 1920s Germany, when the currency halved in value (which caused prices to double in value) once a day.

The disadvantage of this form of inflation is that it essentially makes money worthless. If the value of a currency is reducing by half once a day, then there is little point in hanging onto money. Imagine a bank account with $1,000 in it on Monday, $500 on Tuesday, $250 on Wednesday, and so on--you would be bankrupt before the end of the week.

Stagflation

Stagflation is high inflation combined with high unemployment. Standard inflation is generally acceptable because the economy grows as the value of the currency falls. While the laptop mentioned above may cost $30 more this year than it did last year, someone who made $100,000 last year will probably make around $103,000 this year, so it ultimately evens out.

However, during stagflation the laptop will still cost more but wages will not have risen. The downside of this is that each year people have less to spend than the previous year, which makes the economy shrink further.