Inflation is always
and everywhere a monetary phenomenon.
Milton Friedman
Inflation is a sustained increase in the general price level of goods and services within an economy over a
period of time. During inflation an entity pays more money for the same real value. Inflation is
generally accepted to refer to annual inflation.
All prices are normally quoted in terms of unstable money. During inflation
each unit of the unstable monetary unit buys fewer goods and services.
Inflation has no effect on the real value of non–monetary items.
Inflation
erodes real value evenly in money and other monetary items. Under the
Historical Cost paradigm under which the stable measuring unit assumption is
implemented, there are, consequently, real hidden
monetary costs to some and real hidden
monetary benefits to others from this erosion in purchasing power in
unstable monetary items that are assets to some while – a
the same time – liabilities to others, e.g., the capital amount of a monetary loan. Under the HC paradigm
the debtor generally gains during inflation since he, she
or it (a company) has to pay back the nominal value of the loan, the real value
of which is being eroded by inflation. The debtor pays back less real value
during inflation. The creditor loses out because he, she
or it receives the nominal value of the loan back, but, the real value paid
back is lower as a result of inflation. Efficient
lenders attempt to recover this loss in real value
by charging interest at a rate they hope will be higher than the inflation
rate during the period of the loan.
Nicolaas Smith
Copyright (c) 2005-2012 Nicolaas J Smith. All rights reserved. No reproduction without permission.
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