What is inflation — why money "shrinks" over time

Inflation is the sustained rise in the general level of prices in an economy over a period of time. The key word is "general": we are not talking about a single tomato that got pricier in season, but about a broad trend in which more and more goods and services cost more. The direct consequence is that the purchasing power of money falls: with the same 100 lei you buy less today than you did a few years ago. The money does not "vanish," but the value it represents slowly erodes, like a glacier melting imperceptibly.

How it is measured: the consumption basket

To put a number on inflation, statisticians cannot track every single price in the economy. Instead, they build a representative consumption basket: a list of hundreds of products and services that a typical household buys — bread, rent, fuel, energy, transport, internet, clothes. Each item is given a weight proportional to how much, on average, we spend on it. The price of this basket is tracked month by month, and its annual percentage change forms the Consumer Price Index (CPI).

In the euro area a harmonised version is used, the HICP, which allows fair comparisons across countries. Precisely because it is a weighted average, "official" inflation can differ from the inflation you feel: if a large share of your income goes on energy or rent, and these rise faster than the average, your personal inflation can be higher than the headline figure.

Where it comes from: demand, costs and money

Economists classically distinguish two engines of inflation. The first is demand-pull inflation: when people and firms want to buy more than the economy can produce, prices rise to balance demand against limited supply — "too much money chasing too few goods." The second is cost-push inflation: when raw materials, energy or wages get more expensive, firms pass these costs on into prices, even if demand has not risen. A shock to the price of oil is the classic example.

Behind both there often lies the money supply. If a central bank or a government puts far more money into circulation than the growth in the production of real goods, each unit of currency ends up worth less. This is the core idea of the quantity theory of money, captured by the famous line of economist Milton Friedman. It is not a perfect mechanical law, but it captures an essential truth: money keeps its value only if it stays relatively scarce compared with what you can buy with it.

"Inflation is always and everywhere a monetary phenomenon." — Milton Friedman

The central bank target: why 2%?

Contrary to what you might think, a central bank does not want zero inflation. Low, predictable inflation greases the machinery of the economy: it leaves room for real wages to adjust, it encourages spending and investing rather than hoarding, and it keeps the economy at a safe distance from dangerous deflation. That is why the European Central Bank (ECB) targets a symmetric 2% inflation rate over the medium term — a strategy reaffirmed in 2021 — treating overshoots and undershoots as equally undesirable.

For the leu, the National Bank of Romania (BNR) has a slightly higher target of 2.5% ±1 percentage point, that is a target band between 1.5% and 3.5%. Reality, however, can run well above that band: in May 2026, Romania's annual inflation stood at around 10.9%, the highest in years, and the BNR expected a durable return into the band only towards 2027. Central banks steer inflation mainly through the policy interest rate: higher rates cool demand and lending, lower rates stimulate them.

When it spirals: hyperinflation

At the extreme end sits hyperinflation, a rise in prices so rapid that money loses its meaning. A classic threshold, proposed by economist Phillip Cagan, is inflation above 50% per month — which means prices more than doubling within a few months. Historic examples include 1920s Germany, where people carted money in wheelbarrows, or Zimbabwe and Venezuela in more recent times. In such episodes, people abandon the national currency and flee into hard currency or goods.

Real vs. nominal: the illusion of numbers

Inflation forces you to distinguish between nominal value (the number on the banknote or the payslip) and real value (what you can actually buy with it). If your salary rises by 5% in a year, but prices rise by 8%, in real terms you have become poorer by roughly 3%, even though the figure on your contract went up. Likewise, a 6% interest rate on a deposit looks attractive, but if inflation is 10%, the real interest rate is negative — you lose purchasing power even though you see more lei in the account.

How to protect yourself from inflation

The great enemy of your savings is money kept "under the mattress": non-interest-bearing cash loses value every year, guaranteed, at the rate of inflation. The first line of defence are instruments that pay an interest rate at least close to inflation — deposits, savings accounts, government bonds. Ideally the real interest rate (interest minus inflation) should be positive; even a mildly negative one loses less than plain cash.

Beyond interest, people seek assets that tend to keep their real value over time: shares in solid companies, real estate, sometimes precious metals or inflation-linked bonds. None is guaranteed and each carries its own risk, which is why diversification matters. The golden rule of financial literacy stays simple: understand the mechanism first, only then risk real money.

In Kosron Bank you can see, risk-free, how interest fights the erosion of value: you open a deposit, watch the interest accumulate and compare, on a small scale, money "under the mattress" with money that works for you. But remember: KOSR is a purely educational currency with no real value — a training ground where you can make mistakes calmly, so that you make better decisions with real money.