Inflation is the debasement of money by the government. PERIOD.
It is NOT a general increase in the level of prices for goods and services.
The above statements are critical to an understanding and correct interpretation of events which are happening today - or expected to happen - that are casually attributable to inflation. So, let's go one step further.
There is only one cause of inflation: government. The term government also includes central banks, especially the US Federal Reserve Bank.
Inflation is not caused by "greedy" businesses, excessive wage demands, or accelerated consumer spending. Even government's own propensity to spend, as reckless as it is, does not cause inflation. And that does not contradict my earlier statement that government is the only cause of inflation. They are. But not because of their spending habits.
Economic growth does not lead to higher inflation. There are statements made often that imply a link between growth in our economy and inflation. And that we have to "manage the growth" so the economy doesn't "grow too quickly" and "trigger higher inflation". These statements are false and misleading.
Also, inflation will not "accelerate over the next couple of years due to higher energy prices and stronger wage growth that leads firms to raise prices"...Gus Faucher/PNC Bank/WSJ (It is possible that inflation will accelerate over the next couple of years, but it can't/won't be for the reasons stated.)
So how does the government cause inflation? It's time for a bit of history...
Early ruling monarchs would 'clip' small pieces of the coins they accumulated through taxes and other levies against their subjects.
The clipped pieces were melted down and fabricated into new coins. All of the coins were then returned to circulation. And all were assumed to be equal in value. As the process evolved, and more and more clipped coins showed up in circulation, people became more outwardly suspicious and concerned. Thus, the ruling powers began altering/reducing the precious metal content of the coins. This lowered the cost to fabricate and issue new coins. No need to clip the coins anymore.
From the above example it is not hard to see how anything (grains and other commodities for example) used as money could be altered in some way to satisfy the whims of government. But a process such as this was cumbersome and inconvenient. Of course it was. What a shame. There had to be a better way. And there was.
Enter: Paper Money
With the advent of the printing press (moveable type) and continued improvements to the mechanics of replicating words and numbers in an easily recognizable fashion, paper money was now in vogue - big time.
However, people viewed the new 'money' with healthy skepticism and coins with precious (or semi-precious) metal content continued to circulate alongside the new paper money. Hence, it was necessary, at least initially, for government to maintain a link of some kind between money of known value vs. money of no value (in order to encourage its use).
Over time, eventually, that link was severed; partially at first, then completely. And it was done by fiat (a decree or order of government).
Not only does our money today have no intrinsic value, it is inflated (and therefore debased) continuously and ongoing through subtle and more sophisticated ways such as fractional-reserve banking and expansion of credit. The printing press is still at the core and is humming 24/7 but the digital age has ushered in new and ingenious ways to fool the people.
Government causes inflation by expanding the supply of money and credit. And that expansion of the money supply cheapens the value of all the money. Which is precisely why, over time, the US dollar continues to lose value. It takes more dollars today to purchase what could have been purchased ten years ago, twenty years ago, etc. And it has been going on for over one hundred years. It dates back to the origin of The Federal Reserve Bank in 1913.
What most people refer to as 'inflation' or its causes are neither. They are the effects of inflation. The "increase in the general level of goods and services" are results of the inflation that was already created.
More history... The Arab Oil Embargo in 1973 and the demands for more money for oil which led to the formation of the Organization Of Petroleum Exporting Countries (OPEC) followed close behind then President Nixon's severance of all ties of the US dollar to Gold. The underlying fact of the matter was that the dollars which they were receiving for their oil were worth less (not quite 'worthless') and had been losing value for several decades. And the price had been fixed for decades.
To understand this better, imagine that you were a company selling widgets for $1 each and according to your contract you cannot receive any more than that. Fast forward twenty or thirty years. You are still selling lots of widgets and still receiving $1 for each one you sell. But your costs over the years have continued to climb. And it also costs you more for everything you buy to maintain your standard of living. And it's not just you. Everyone is paying more for everything. Yet, on an ongoing, year-to-year basis, things seem reasonably normal. But prices now are rising more frequently and the rate of increase is higher than before. What is going on?
The effects of inflation are showing up. Those effects can be very subtle at first, or not noticed at all. But at some point in time the cumulative effects of inflation become more obvious and everyone starts acting differently. Businesses try to plan for it and individuals invest with inflation in mind.
If your dollars were freely convertible into equivalent amounts of gold based on the prices in effect at the time of your original contract to produce widgets - or sell barrels of oil - then you could just exchange your dollars for gold. Which is exactly what happened. Foreign governments in the late sixties began to demand the gold to which they were legally entitled. And countries which produced and sold oil wanted a higher price for their oil. Wouldn't you?
As people become more aware of the effects of inflation they start looking for reasons. And for guilty parties. Government is quick to act of course. They start by implementing wage and price controls. This is like setting the stove burner on 'high' and putting a lid on the pot with no release for the pressure. And they talk a lot.
They have talked enough over the past thirty years to frighten us into thinking that our own spending and saving habits are the problem. Sometimes the blame is directed at foreign countries and their currencies (China/Yuan for example).
Our sense of 'unfairness' over China's attempts to weaken the Yuan seem to be misplaced. We criticize them for doing the same things the US government and Federal Reserve have been doing for over one hundred years.
The inflation (expansion of the supply of money and credit) produced by the Federal Reserve is deliberate and intentional. And ongoing. The effects of that inflation are volatile and unpredictable.
Even with the hugely, inflationary response of the Federal Reserve in 2008 and afterwards we did not see the "obvious substantial increase in the general level of prices for goods and services" that some expected and predicted. But we did see a resurgence of higher prices for financial assets like stocks and real estate.
During the seventies, prices for basic necessities were rising on a weekly, even daily, basis. But things eventually settled down and we had an extended period of stability and relative US dollar strength for a couple of decades.
And yet, the effects of inflation are very clear. How much are you paying for things today compared to fifteen years ago? Ten years ago?
As time marches on, the effects of government inflation will become more extreme and more unpredictable. And the loss of purchasing power of the US dollar will reflect that.