In contemporary usage, a sustained rise over time in the general level of prices, normally measured by a weighted index of prices of a large and representative sample of goods and services (both consumers' goods and producers' goods) regularly traded in the economy under consideration. (In 19th century usage, the term referred more specifically to any sustained expansion in the stock of money available within the economy under consideration -- the eventual consequence of which would normally be a generalized increase in prices.)

When the quantity of money available in the economy begins to exceed the amount that firms and households (in the aggregate) feel they wish to keep on hand to finance their expected volume of trading in the foreseeable future, people tend to increase their rate of spending all at once, shifting the demand curves for nearly all goods and services to the right at the same time and thus driving up the general price level -- which is just another way of saying that each unit of money begins to be worth less than before in its purchasing power. Such an acceleration of spending may happen for any of a number of reasons:

  1. The money stock itself is rapidly expanding

  2. The available stocks of many goods have suddenly shrunk dramatically due to natural disaster, wartime destruction, or political interruption of established international trading relationships through embargoes or blockades

  3. The average amounts of money people want to keep on hand is shrinking due to rising guesstimates of what future inflation rates might be

  4. Increasing availability of new close money-substitutes like credit cards, or

  5. because households' willingness or ability to save is for some reason sharply decreasing.

History strongly suggests, however, that sustained inflation at rates of more than four or five percent per year in "normal" times is nearly always due primarily to government or central bank policies of rapid monetary expansion rather than to anything else that may be going on in the private sector to influence the public's demand for cash balances.

If the money stock continues to increase a great deal faster than the public's total demand for cash holdings, the inflationary process begins to feed upon itself. Initial experience with accelerating inflation quickly convinces the public that the future purchasing power of their money holdings is going to be very much less than it is in the present -- leading people to reduce still further their desired amounts of money to hold and further accelerating the general rise in prices because of their desperate efforts to spend away their money as quickly as possible, before its value melts away. When such an inflationary panic once takes hold, the result is apt to be hyperinflation, in which prices may begin increasing by several hundred percent (or even several thousand percent) per month until the monetary system collapses altogether and people resort to primitive barter (or the use of more stable foreign currencies, if available) rather than accept the government's worthless money as payment for their goods or services.

[See also: hyperinflation, money, money stock, monetary policy, Phillips' curve]