Types of Inflation: The Four Most Critical Plus Nine More

Creeping Inflation

Creeping or mild inflation is when prices rise 3% a year or less. According to the Federal Reserve, when prices increase 2% or less, it benefits economic growth. This kind of mild inflation makes consumers expect that prices will keep going up. That boosts demand. Consumers buy now to beat higher future prices. That's how mild inflation drives economic expansion. For that reason, the Fed sets 2% as its target inflation rate.

Walking Inflation

This strong, or destructive, inflation is between 3-10% a year. It is harmful to the economy because it heats-up economic growth too fast. People start to buy more than they need to avoid tomorrow's much higher prices. This increased buying drives demand even further so that suppliers can't keep up. More important, neither can wages. As a result, common goods and services are priced out of the reach of most people.

Galloping Inflation

When inflation rises to 10% or more, it wreaks absolute havoc on the economy. Money loses value so fast that business and employee income can't keep up with costs and prices. Foreign investors avoid the country, depriving it of needed capital. The economy becomes unstable, and government leaders lose credibility. Galloping inflation must be prevented at all costs.

Hyperinflation

Hyperinflation is when prices skyrocket more than 50% a month. It is very rare. In fact, most examples of hyperinflation occur when governments print money to pay for wars. Examples of hyperinflation include Germany in the 1920s, Zimbabwe in the 2000s, and Venezuela in the 2010s. The last time America experienced hyperinflation was during its civil war.

Stagflation

Stagflation is when economic growth is stagnant, but there still is price inflation. This combination seems contradictory, if not impossible. Why would prices go up when there isn't enough demand to stoke economic growth?

It happened in the 1970s when the United States abandoned the gold standard. Once the dollar's value was no longer tied to gold, it plummeted. At the same time, the price of gold skyrocketed.

Stagflation didn't end until Federal Reserve Chairman Paul Volcker raised the fed funds rate to the double-digits. He kept it there long enough to dispel expectations of further inflation. Because it was such an unusual situation, stagflation probably won't happen again.

Core Inflation

The core inflation rate measures rising prices in everything except food and energy. That's because gas prices tend to escalate every summer. Families use more gas to go on vacation. Higher gas costs increase the price of food and anything else that has high transportation costs.

The Federal Reserve uses the core inflation rate to guide it in setting monetary policy. The Fed doesn't want to adjust interest rates every time gas prices go up.

Deflation

Deflation is the opposite of inflation. It's when prices fall. It's caused when an asset bubble bursts.

That's what happened in housing in 2006. Deflation in housing prices trapped those who bought their homes in 2005. In fact, the Fed was worried about the overall deflation during the recession. That's because deflation can turn a recession into a depression. During the Great Depression of 1929, prices dropped 10% a year. Once deflation starts, it is harder to stop than inflation.

Wage Inflation

Wage inflation is when workers' pay rises faster than the cost of living. This kind of inflation occurs in three situations. First is when there is a shortage of workers. Secondly, is when labor unions negotiate ever-higher wages. Thirdly is when workers effectively control their pay.

A worker shortage occurs whenever unemployment is below 4%. Labor unions negotiated higher pay for autoworkers in the 1990s. CEOs effectively control their pay by sitting on many corporate boards, especially their own. All of these situations created wage inflation.

Of course, everyone thinks their wage increases are justified. But higher wages are one element of cost-push inflation. That can drive up ​the prices of a company's goods and services.

Asset Inflation

An asset bubble, or asset inflation, occurs in one asset class. Good examples are housing, oil, and gold. It is often overlooked by the Federal Reserve and other inflation-watchers when the overall rate of inflation is low. But the subprime mortgage crisis and subsequent global financial crisis demonstrated how damaging unchecked asset inflation could be.

Asset Inflation -- Gas

Gas prices rise each spring in anticipation of the summertime vacation driving season. In fact, you can expect gas prices to rise ten cents per gallon each spring. But political uncertainty in the oil-exporting countries drove gas prices higher in 2011 and 2012. Prices hit an all-time peak of $4.06 in July 2008, thanks to economic uncertainty. 

What do oil prices have to do with gas prices? A lot. In fact, oil prices are responsible for about two-thirds of gas prices. The rest is distribution and taxes. They aren't as volatile as oil prices. 

Asset Inflation -- Oil

Crude oil prices hit an all-time high of $145.31 a barrel in July 2008. This inflation-adjusted price was despite a decrease in global demand and an increase in supply. Commodities traders determine oil prices. Those traders include both speculators and corporate traders who are hedging their risks. Traders bid up crude oil prices in two situations. First, is if they think there are threats to supply, such as unrest in the Middle East. Second, is if they see an uptick in demand, such as growth in China.

Asset Inflation -- Food

Food prices soared 6.4% in 2008, causing food riots in India and other emerging markets. They spiked again in 2011, rising by 4.8%. High food costs led to the Arab Spring, according to many economists. Food riots caused by inflation in this important asset class could reoccur.

Asset Inflation -- Gold

An asset bubble occurred when gold prices hit the all-time high of $1,895 an ounce on September 5, 2011. Although many investors might not call this inflation, it sure was. That's because prices rose without a corresponding shift in gold's supply or demand. Instead, investors ran to gold as a safe-haven. They were concerned about the declining dollar. They felt gold protected them from hyperinflation in U.S. goods and services. They were uncertain about global stability.

What spooked investors? In August, the jobs report showed absolutely zero new job gains. During the summer, the eurozone debt crisis looked like it might not get resolved. There was also stress about whether the United States would default on its debt. Gold prices rise in response to uncertainty. Sometimes it's to hedge against inflation. Other times it's the exact opposite, the resurgence of recession.