The Inflation Rate:

A third major economic indicator is inflation rate.

A high inflation rate -- more than 20% a month, let’s say--can cause enormous economic destruction, because the price system breaks down and the chance of using profit-and-loss calculations to make rational business decisions disappear. Such episodes of hyperinflation are among the worst economic failures that are capable of befall an economy. But not since Revolutionary War has the U.S. experienced hyper inflation. Box Below tracks the inflation rate in U.S. over the last century.

Strangely, moderate inflation rates--a little more than 10% per year, say--are highly unsettling to customers and business managers. Moderate inflation must not seriously compromise customers’, investors', and managers' skill to decide the best use of their financial funds or to calculate profitability. Yet every one of these groups are strongly averse to it. Politicians in industrialized economies have discovered that if they be unsuccessful to preside over low and steady inflation rates then they are likely to lose the next election.

In the U.S. in the 20th century major peaks of inflation took place at the time of World Wars I and II, when overall rates of price raised to top at more than 20% per year (see Figure below). Before World War II, deep recessions such as the Great Depression of the 1930s were accompanied by “deflation: a drop in the level of overall costs which bankrupted businesses and banks, exacerbating the reduce in employment and output.
 
The steep decline in inflation which happened in early 1980s is called the Volcker disinflation, subsequent to the Federal Reserve Chair Paul Volcker. Alarmed by the accelerating inflation of late 1970’s and early 1980’s, Volcker chose to increase interest rates in order to reduce aggregate demand. In doing so he risked a great recession, which came in 1982-1983. But his this action did stop the increase in inflation and decrease it back to "creeping" range.

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