Inflation

What is inflation and how many types of inflation are there? What are the consequences of rising prices? As interest rates move, how do household consumption and investment choices change? Take the quiz to find out how knowledgeable you are about inflation.

You received €1,000 as a gift, but you will only be able to spend it in a year's time. Imagine that the annual inflation rate is 1 per cent. In a year's time, you will be able to buy exactly the same things with that sum as you would buy now.

Correct answer B. False.

Yes, it really is false! In market economies, the prices of goods and services can change at any time: some rise, others fall. Inflation occurs when there's a general increase in prices, which is not limited to individual items of expenditure. When there's inflation, a unit of money (e.g. €1) makes it possible to buy a smaller quantity of goods and services: the real (effective) value of the unit of money is lower than in the past or, in other words, inflation reduces the purchasing power of money.

High inflation means that the cost of living increases rapidly.

Correct answer A. True.

When thinking about our future situation, especially when looking at a horizon longer than five years, it's good to take into account the effects of inflation.

The value of €1 today is greater than the value of €1 five years from now if there is inflation. When entering into contracts for financial products or services, we need to be clear about whether how much we have to pay also depends on general price developments.

Which of the following statements is true? (Only one answer is correct)

Correct answer A. If people's demand for a good or service increases and exceeds the supply, the price increases (demand-driven inflation).

Demand inflation occurs when consumer demand for goods and services exceeds the quantity offered on the market. Supply inflation, on the other hand, occurs when the quantity of goods and services people want to buy doesn't change, but either production capacity is reduced or costs increase. High inflation, regardless of its cause, makes consumption and investment decisions more difficult for households and firms. It raises interest rates, making investments more expensive; it affects savings accumulated over time, reducing their value. Not only does it reduce the real value of earnings or savings, but also that of debts. In other words, for those who are in debt at a fixed rate and pay an instalment of the same amount every month, inflation is a benefit.

Why is inflation called an 'unfair tax'?

Correct answer B. It's a 'tax' that reduces the amount of goods and services that can be purchased for everyone, and is 'unfair' because it doesn't affect everyone equally.

Inflation affects those who have less because poorer people consume a greater share of their income to buy basic necessities (food, energy, transport) which are often subject to higher price increases.

More generally, the rising cost of living may make it impossible to cover expenses people can't live without (basic needs) with their income, forcing poorer people to eat into their savings, supposing they have any.

In the Eurosystem, the Governing Council of the European Central Bank (ECB) has established that the price stability target is an inflation rate in the euro area of?

Correct answer A. 2 per cent in the medium term.

The 2 per cent target was chosen because, on the one hand, it represents a level of inflation that doesn't come at too high a cost to the economy and citizens and, on the other hand, it provides an adequate safety margin against the risk of deflation (a continuous and generalized reduction in prices).

Deflation can be just as damaging as high inflation: when households and firms expect prices to fall, they tend to postpone purchases or investments in order to pay less in the future, with negative effects on the economy's performance.

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Inflation