How Does Inflation Affect the Value of Money?

Inflation is caused by having too much money in circulation.
Image Credit: tang90246/iStock/Getty Images

Inflation refers to a continuous increase in the price level, which is an index of the prices of all goods in the economy. Inflation is caused when the government creates money at a faster rate than the growth of the economy. The government should expand the money supply enough to fuel economic growth but not so much that it destroys the value of money

Changing the Value of Money

The Federal Reserve controls the money supply in the United States and must create enough money to facilitate economic activity. As is the case with any product, the value of money is subject to the laws of supply and demand. Without corresponding growth in the economy, which would increase demand, expanding the money supply will diminish its value. Inflation does not affect all people equally. Debtors gain while creditors lose. Inflation tends to help debtors because the money they repay is worth less than the money they borrowed. Inflation hurts people who wish to save because it eats away at the value of what they have put away. Economists and government policy makers agree that a little inflation is acceptable -- even good -- for the economy. Too much inflation makes consumer and business transactions difficult, because people must factor the declining value of money into their decision-making process. Hyperinflation occurs when the inflation rate is extremely high. One example occurred in Germany between the world wars. Inflation hit 322 percent, destroying the value of the German mark.