Why do central banks target 2% inflation rather than zero?

Zero inflation is dangerous because of its proximity to deflation — falling prices that can push consumers to defer spending and spiral into a self-reinforcing depression. A 2% buffer gives the central bank room to cut real rates during a recession. The CPI also slightly overstates actual inflation by failing to capture quality improvements, so 2% CPI is close to genuine price stability. Finally, mild inflation lubricates labour markets: firms can cut real wages through wage freezes rather than unpopular nominal cuts.

What is stagflation and why is it so difficult to cure?

Stagflation is the simultaneous combination of high inflation and economic stagnation with elevated unemployment. It is difficult to cure because standard tools conflict: raising rates to fight inflation deepens the recession, while stimulating growth to reduce unemployment worsens inflation. The classic example was the 1973 and 1979 oil shocks. Resolution in the early 1980s required Paul Volcker's Fed to maintain extremely high rates — triggering a sharp recession — until inflation expectations were broken.

How does inflation affect different groups in society?

Inflation redistributes wealth between groups. People on fixed incomes — retirees, welfare recipients — suffer as their nominal incomes don't keep pace with prices. Holders of real assets (property, equities) are generally protected as asset values rise with inflation. Debtors benefit because the real value of fixed obligations erodes; creditors lose. Hyperinflation typically devastates middle-class savers while those with foreign currency or real estate holdings are shielded.

What distinguishes hyperinflation from ordinary inflation?

Hyperinflation is conventionally defined as monthly price increases exceeding 50%. The qualitative difference is that under hyperinflation money effectively ceases to function as a store of value and unit of account: people abandon the national currency in favour of foreign currencies, gold, or barter. Economic calculation becomes nearly impossible. Hyperinflation is almost always the product of fiscal dominance — government financing expenditure through money creation — combined with a complete collapse of confidence in fiscal institutions.

How did Ukraine overcome its 1990s hyperinflation?

After Soviet collapse, Ukraine inherited a command economy with loss-making state enterprises and no market price mechanisms. The government covered deficits by printing karbovantsi, producing hyperinflation of 10,255% in 1993. Stabilisation was achieved through the 1996 currency reform (introducing the hryvnia), tight monetary and fiscal discipline, and IMF programme conditionality. The NBU's adoption of inflation targeting in 2016 completed the institutional transformation of Ukrainian monetary policy.

Economic Terms

Inflation

Updated At: June 10, 2026

What is Inflation?

Inflation is the sustained, broad-based increase in the general price level of goods and services in an economy over time, which results in a decline in the purchasing power of money. If a basket of goods cost $100 last year and costs $110 today, inflation was 10%. Moderate inflation (around 2%) is considered normal and even desirable in a market economy; high or hyperinflation is a destructive process that erodes savings, distorts economic decisions, and can destroy social and political stability.

Measuring Inflation

Consumer Price Index (CPI) — the most common measure; tracks the cost of a representative consumer basket covering food, clothing, housing, transport, and healthcare.
GDP deflator — a broader measure covering all goods and services produced in the economy.
Producer Price Index (PPI) — tracks prices at the production stage; a leading indicator of future consumer inflation.
Core inflation — CPI excluding food and energy (the most volatile components), giving a cleaner signal of underlying price trends.

Types of Inflation

Moderate inflation (below 10% per year) — normal in most developed economies; consistent with expansion.
High inflation (10–100% per year) — destabilises planning, erodes savings, reduces real incomes.
Hyperinflation (over 50% per month) — catastrophic; typically occurs during wars, revolutions, or collapse of fiscal credibility.
Stagflation — the combination of high inflation and economic stagnation; the classic example is the 1970s oil shocks in developed countries.
Demand-pull inflation — prices rise when aggregate demand exceeds productive capacity ("too much money chasing too few goods").
Cost-push inflation — caused by rising production costs (raw materials, labour, energy) passed through to consumers.

Causes of Inflation

1. Monetary expansion — excessive growth of the money supply relative to real output. The quantity theory of money (MV = PQ) implies that if money supply grows faster than real GDP, prices tend to rise.

2. Budget deficits and debt monetisation — governments that finance deficits by printing money rather than borrowing generate inflationary pressure.

3. Supply shocks — a sudden rise in the price of key inputs (oil, grain) raises production costs throughout the supply chain.

4. Inflationary expectations — if businesses and households expect higher future prices, they demand higher wages and raise prices now, creating a self-fulfilling prophecy.

5. Imported inflation — currency depreciation raises the cost of imports, feeding through to domestic prices.

Consequences of Inflation

Negative: erosion of purchasing power of fixed incomes and savings; wealth redistribution from creditors to debtors; uncertainty that discourages long-term investment; higher borrowing costs.

Conditionally positive: mild inflation encourages current spending; reduces the real burden of debt; gives central banks room to cut real rates during recessions.

Famous Historical Hyperinflations

Weimar Germany (1921–1923) — the most famous modern hyperinflation. Germany printed money to pay war reparations and domestic expenses. Prices roughly doubled every three days at the peak; the Reichsmark was replaced by the Rentenmark in November 1923.

Hungary (1945–1946) — the largest hyperinflation ever recorded. The peak daily inflation rate reached 207%. The pengo was replaced by the forint at a rate of 400 octillion pengo per forint.

Zimbabwe (2007–2008) — the Mugabe government printed money to finance land reform and state expenditure. Inflation reached an estimated 89.7 sextillion percent at its peak; Zimbabwe abandoned its currency and dollarised.

Venezuela (2016–2019) — as oil revenues collapsed and the government monetised its deficit, inflation exceeded 1,000,000% per year.

Ukraine (1993) — in the wake of Soviet collapse, inflation reached 10,255% annually. The 1996 currency reform replaced the karbovanets with the hryvnia, and tight monetary policy gradually stabilised prices.

Controlling Inflation

Raising the policy rate — dearer credit reduces demand and price pressure.
Reducing the fiscal deficit — cutting spending or raising taxes.
Inflation targeting — the central bank publicly announces a target and adjusts rates to achieve it; now the dominant global monetary framework.
Price controls — administrative ceilings; historically ineffective over time and produce shortages.

Frequently Asked Questions

Economic Terms