Inflation
Have you noticed your grocery bill climbing… while your shopping cart keeps shrinking? That’s inflation at work—silently eating away your money. But why is this happening, and what can you do about it? In this article, we’ll break down:
✅ What inflation is
✅ Why it happens
✅ Future inflation trends
What is inflation?
Inflation is the decrease in the purchasing power of your currency. For instance, 20 years ago, a gallon of milk cost under $3, but today, it’s over $4. A dozen eggs, once priced at $1, now costs around $4. The average cost of a house in the U.S. has surged from $200,000 to $500,000 in the same period.
This doesn’t mean these items have simply become more expensive; rather, it indicates that the value of your money has diminished. The price change varies for different items, which is why governments use a measure called the Consumer Price Index (CPI). The CPI tracks changes in the average prices of a set of consumer goods and services—such as food, housing, transportation, and healthcare.
Over the past 20 years, the cumulative inflation rate, measured by CPI, has increased by 66% in the U.S. This means an item that cost $100 twenty years ago now costs $166.
Is inflation only a problem in the U.S.?
Hell no! Inflation is a global problem. For example, in Poland, where I live, the cumulative CPI over the last 20 years has reached 91%. That means if an item cost 100 PLN in 2004, today it costs 191 PLN—almost twice as much!
Many other countries have experienced inflation at similar levels, and in extreme cases, even hyperinflation.
Hyperinflation occurs when prices rise so quickly that money becomes almost worthless. Imagine you go to the store today, and a loaf of bread costs $1. By tomorrow, the same bread could cost $10. Within a week, prices could jump to $100, and the increases keep accelerating. That’s hyperinflation.
Now, don’t get me wrong—hyperinflation is an extreme event that usually occurs due to war, revolution, or a total economic collapse. While I don’t foresee hyperinflation happening in major economies like the U.S., Eurozone, or Poland anytime soon, history has shown that it’s not impossible.
Historical Examples of Hyperinflation
One of the most famous cases of hyperinflation occurred in Germany in the 1920s, following World War I. The price of bread skyrocketed from 0.25 marks to 200 billion marks in just a few years.
A more recent example is Venezuela, where in 2018, inflation reached over 1 million percent. Everyday necessities like food, medicine, and gas became nearly impossible for ordinary people to afford.
While Poland hasn’t experienced hyperinflation on that scale, it did face significant inflation in the late 1980s and early 1990s, during the collapse of communism, with inflation reaching around 600%.
Understanding the Main Reasons for Inflation
Ok, but let’s come back to modern-day inflation in developed countries. Why is it happening? What are the reasons for it?
First of all, there might be temporary events in the world that cause spikes in inflation. For example, oil supply shocks, new tariffs, or supply chain interruptions.
And this is logical. For example, OPEC countries might decide to extract less oil in the coming months.
Less oil on the market results in higher gas prices.
Higher gas prices lead to increased transportation and manufacturing costs.
Fun fact: oil isn’t just fuel—it’s also a key raw material in the production of plastics, synthetic materials, chemicals, and many other products.
Ok, but does this mean you should start obsessively tracking global news, trying to predict which events might impact prices at your local store? I wouldn’t go so far.
The most attention-grabbing headlines are designed to stir emotions—especially fear—rather than provide a balanced perspective.
Instead, I focus on the bigger picture. And to truly understand inflation, we need to examine the most important factor of all—MONETARY POLICY.
Most national currencies have their own central bank that dictates that policy.
For example:
- In the US, it is the FED (Federal Reserve).
- In the Eurozone, it is the ECB (European Central Bank).
- In Poland, it is the NBP (National Bank of Poland).
The main objective of central banks is to keep inflation under control.
But what does it really mean to keep inflation under control? By the inflation numbers I showed you at the beginning, we clearly see they don’t do a good job, right?
Well, most economists around the world agree on the theory that a small inflation rate of around 2% per year is beneficial for the economy.
This is because it encourages spending and investment, which makes sense. If prices are expected to rise slightly over time, people and businesses are more likely to spend and invest, which stimulates economic growth.
Inflation also prevents deflation (falling prices). At first, falling prices sound good, but it might reduce consumer spending—people delay purchases expecting lower prices, which slows down the economy, reduces wages, and increases unemployment. That’s why central banks and governments around the world are so afraid of deflation and would do whatever it takes to avoid it.
Additionally, inflation helps to manage debt.
With moderate inflation, the real value of debt decreases over time, making it easier for businesses and governments to repay loans.
Fun fact: the biggest borrowers around the world are governments. Now that we know inflation helps repay loans, we can be pretty sure that governments don’t want inflation to go away.
With all that said, central banks set inflation targets.
For example, the FED seeks to achieve an annual inflation rate of 2% over the long run.
The ECB also targets 2% annually.
On the other hand, the National Bank of Poland targets an inflation rate of 2.5%.
What tools do central banks have to manipulate inflation?
The most important tool is setting interest rates. The interest rate affects the cost of borrowing money for businesses, governments, and individuals.
For example, if inflation is too high, the central bank would increase interest rates, which would, in turn, increase the cost of borrowing money. This means less money is being borrowed, which limits economic activity and the money supply.
On the other hand, if inflation is too low, the central bank would cut interest rates, making borrowing money cheaper. More money is borrowed, which increases the money supply and economic activity, leading to higher inflation.
In extreme situations, when the central bank is afraid of a deep recession, it might go a step further and print money. This means the central bank would not only allow governments, businesses, or individuals to borrow money cheaply, but it would also create new money and inject it into financial markets and the economy. All of this is done to increase economic activity.
This is exactly what happened during COVID, when the FED not only cut interest rates to almost 0%, drastically reducing the cost of borrowing money, but also printed tons of money.
On the chart, we see the total money supply in the United States. Since February 2020, the money supply increased from $15,000 billion to $18,000 billion in just four months. By April 2022, the total money supply in the US reached almost $22,000 billion. This is a 40% increase in all of the money in the US in just over two years. According to basic economic principles, when the supply of a good increases significantly, its value declines. Given this, it’s no wonder the US dollar lost 8% of its purchasing power in 2022 alone.
The FED was not alone. Other central banks around the world followed the same policy of cutting interest rates and printing money, which resulted in high inflation almost everywhere.
Does this mean all of the new $7,000 billion in the US were simply printed by the FED?
Not exactly. Most of the new money supply in the modern world is actually created by commercial banks. Yes, you heard me right—commercial banks can create new money.
This happens through fractional reserve banking, where banks issue loans that effectively create new money.
When a bank gives out a loan, it does not take that money from existing deposits. Instead, it creates new money electronically by crediting the borrower’s account. This increases the broad money supply.
In a step-by-step example, let’s imagine:
- Emily deposits $1,000 in Bank A. At this point, Bank A holds $1,000 in deposits and $1,000 in reserves.
However, fractional reserve banking allows banks to keep only 10% of their assets in reserves.
In our example, Bank A is mandated to keep at least $100 in reserves, meaning it can lend out the remaining $900 to, for example, John. - John now takes this $900 and buys a laptop.
Now, the $900 that the shop has earned is deposited into Bank B, which now has $900 in deposits and reserves. - But again, Bank B keeps 10% as reserves ($90) and lends out the remaining $810, which will ultimately be deposited into another bank.
The process repeats, with each new bank keeping 10% in reserves and lending the rest.
What is the final effect? Money supply expands.
The original deposit was only $1,000, but the total money in circulation increases due to repeated lending.
Based on above formula, an initial $1,000 deposit can generate up to $10,000 in the economy through repeated lending.
Due to the fractional reserve banking system, the total money supply is continuously expanding, with the process accelerating dramatically during the COVID period.
The most important lesson here is that inflation isn’t a coincidence; it’s a built-in feature of the system.
How Inflation Devalues Your Money
Now you might say, ‘Okay, Piotr, 2% annual inflation isn’t that bad, huh?’
And I would agree with you—in the short term, it’s not a big deal. If you have savings that you plan to use in the next year or two, keeping them in a savings account or even in cash might not be a bad idea. It’s definitely better than investing in risky assets, especially if you don’t have much experience with investing.
However, even an annual inflation rate of 2% can be devastating in the long term, table below shows how:
As you can see with annual inflation 2% after 35 years you are left with money worth only $50, a half what it used to be
This was ideal scenario when the central bank always delivers on the inflation target. But history teaches us it is not always a case. Let’s assume now a bit worse scenario with 4% annual inflation rate.
This is even more devastating as after 20 years they money already lost 50% of it’s value. After 35 years mentioned $100 is worth only $25
That’s bad, don’t you think so?
Future Inflation Trends
Ok, so what are my inflation predictions and what we can do about them?
First of all I Am not an economist, nor do I have a crystal ball – so I don’t know how to predict inflation, in fact it is really hard, almost impossible to foresee it in the long term. However I can tell you, what are inflation expectations of respective central banks or analytics agencies:
- National Bank of Poland expects CPI in Poland at rates:
- 5.6% in 2025
- 2.7% in 2026
- tradingeconomics.com expects inflation in the US to be
- between 2.4% and 2.9% in 2025
Given these expectations, both Poland and the US remain above their inflation targets.
As we discussed in the previous section, inflation is an inherent part of the system due to several factors:
- Commercial banks continuously create new money under the fractional reserve banking system.
- Central banks intentionally set inflation targets at 2% or higher.
- Governments, as the largest borrowers, benefit the most from inflation.
Considering these points, it’s likely that low levels of inflation will persist in the long run.
Can you protect your money from inflation?
Can you protect your money from inflation? Absolutely! There are several ways to do it—from simple bank deposits (which, unfortunately, often lag behind inflation) to investment options like bonds, stocks, real estate, or even Bitcoin.
If you want to learn more about these investment opportunities—especially how to invest in them in Poland—be sure to come back to this blog as I’ll be covering them in detail and providing step-by-step tutorials on how to get started.