What causes inflation?

for really good, clear explanations of economic ideas for the uninitiated, try "economics explained" by robert heilbrun.

I think there are two initial concepts one must realize to start understanding inflation. First - money can be perceived as a product, which has a market and a price of its own. Think of it this way - as a consumer, you receive money over two periods of time, but you can also trade between those periods of time - you can lend or borrow. The "price" which enables you to trade between money today or tomorrow is the interest rate.

If the interest rate is high, it is expensive to borrow and profitable to lend.

Second, think of what happens when a product is abundant. When there is a very large supply of a certain product, it becomes worth less and less. The same is true for money - think of it this way: A lemonade salesman notices that all his customers, for some reason, earn more money, therefore, he decides to raise the price of his lemonade. The ice cream woman, and the ISP's follow. Well, all the employees who have noticed the prices going up are starting to get mad and they now demand another raise and so forth...

Now, what the government can do sometimes is play with the interest rate - the central bank can induce people to put money in the bank and keep it for the future by issuing bonds or by selling foreign currency from its reserves.

The real problem is, however, that inflation is has a very strong psychological effect - people sometimes don't believe the central bank will be able to stop the inflation, everybody raises prices in fear that they might lose if they don't. Sometimes people don't believe that the central banks have enough money to pay them back. Sometimes the foreign currency reserves are emptied etc. All these factors lead to severe instability which could result in an economic disaster.

(this last paragraph is a short description of what hyper inflation is).

There is much more to write, but this is getting long, so let me know if this is clear and/or sufficient.

Clear and an example of how to write - moving from the abstract to the concrete and back again. A gift to your readers, some of them economic dolts (read; me) and yet able to understand. You didn't name yourself taxlover for nothing, I guess. Now, how about explaining deflatiion and economic depression...

I knew Bob Heilbrun, who was also a good writer (but rotten to his former wife so I no longer read his books...:- < )

Thanks... Well, without having studied this, I am assuming that deflation is simply the opposite of inflation. For some reason, we start to get worried about our future income and we want to transfer some of it to the future. Perhaps the central bank also wants to induce people to save a bit more, perhaps it's a social thing (I am told the Japenese tend to save more for example). Money is become a bit scarce, and people who are saving can't afford to buy things. Well, shopkeepers will have to decrease prices to attract customers.

Now, how is this related to depression? At this point I must emphasize that it's been a while since I've done any macroeconomics, but here is what I think - please don't rely on this:

First, some claim that there is a certain cycle between depression and periods of growth (like the cycle of ebb and tides). But let's forget about that... I think the connection is that deflation could result in less economic activity. I will give an example: We said that deflation could result from high interest rates which would cause people to put money in the banks and keep it to the future. The problem is that when the bank offers a good deal, suddenly, a lot of other investment deals sound less attractive. People go - well, I'd rather put my money in the bank or buying bonds instead of opening a new website or buying a building and renting it out (Obviously, this example is very simplified because it doesn't account for the risk factors associated with every investment, but let's, for the purpose of this discussion, assume that you can easily compare the different investments with putting the money in the bank by calculating their expected return and "deducting" the risk)

What is the result then? Less economic activity, and probably, less growth in the near future, until the investments become more lucrative. This is by no means a comprehensive explanation, but it could help understand why a low inflation rate (and not 0%) is desirable - it's considered as "oil" for the economic machine.

Regarding inflation and its effect on depression. Well, I implied how this happens through hyperinflation. Imagine an economic system where everybody raises prices without any control, only because everybody else is raising prices without control. Money becomes literally worthless... At best, the government takes control of the situation and regulates prices, get's help from the IMF or something like that. But if you have an unstable society - people could start to steal food which they can no longer afford to buy. In short, what happens is that people do not trust the economic system, contracts suddenly become much riskier, money you hid under the floor tiles (Israeli expression) is worthless and so is the regular checking account. It's clear that as long as there is no confidence and everything seems risky, economic activity is slowed down.

Once again, I hope this was clear...

Indeed. Find an agent and publisher. (Here we say "under the mattress;) it must mean the same thing...I remember listening to a very old man lecturing to a HS history class about growing up in Nazi Germany and trying to save up for a soccer ball. By the time he had collected the suitcase full of Deutschmarks, the money wouldn't buy the carton, much less the ball.

Inflation is caused by all the stupid people who do not know that when they refinanced their houses, the money they get, is due to pay back. And instead of doing something productive with the money, they just go to the dealership and buy themselves a very fancy car. In other words, you should not lend money to idiots!!!

http://thebenjamins101.blogspot.com

Inflation has been described as “too much money chasing too few goods and services.” It’s an old and continuing problem. When the Spanish imported large quantities of gold and silver from the New World, it caused a raging inflation because there was suddenly a lot more money to buy about the same level of goods and services. Governments cause inflation when they spend too much money and have to borrow or print it. The Effect is the same.