Embedded Files
Helpful prior knowledge and learning objectives
Helpful prior knowledge and learning objectives
Helpful prior learning:
Section 1.1.1 The economy and you, which explains what an economy is and how it is relevant to students’ lives
Section 1.1.2 The embedded economy, which explains the relationship between the economy and society and Earth’s systems
Section 5.1.1 The state as a system, which defines the state, its parts and their relationships, and some ways to classify states
Section 5.1.2 Origins, legitimacy and power of states, which explains how states came about, how they gain legitimacy and maintain power
Section 5.1.3 State functions, which explains the various roles of the state in providing goods and services, protecting the population, and stabilising and guiding change
Section S.1 What are systems?, which explains what a system is, the importance of systems boundaries, the difference between open and closed systems and the importance of systems thinking
Section S.2 Systems thinking patterns, which outlines the core components of systems thinking: distinctions (thing/other), systems (part/whole), relationships (action/reaction), and perspectives (point/view)
Section S.3 Systems diagrams and models, which explains the systems thinking in some familiar information tools as well as the symbols used to represent parts/wholes, relationships and perspectives.
Section S.5 Causal loops, feedback and tipping points, which explains the feedback loops that can stabilise or destabilise systems.
Section S.8 Leverage points, which describes various leverage points for systems change
Section S.9 System traps, which explains how system structures, like reinforcing feedback, too weak or late balancing feedback, and/or pursuing flawed goals, can create persistent problems.
Learning objectives:
explain the importance of price stability and how it is measured
explain why price levels change, including demand-pull and cost-push factors and the role of reinforcing feedback loops of expectations
discuss the uses and limitations of current state strategies for price stability, and alternatives that could support regenerative economic goals
In the early 1920s, Germany experienced extreme price increases across the entire economy, called hyperinflation. At first, prices rose slowly. Then they spiralled out of control. A loaf of bread that cost 250 marks one week could cost 20,000 the next. By November 1923, it cost 200 billion. People needed wheelbarrows of cash just to buy groceries. Wages were paid twice a day so workers could spend their money before prices rose again (Figure 1).
Stable prices are important for an economy. When prices rise too quickly, people struggle to afford food, housing, and other essentials. Savings lose value. Planning becomes difficult. In Germany, hardship and anger during the hyperinflation helped extremist groups rise to power and led to German aggression in World War II. Today, fast-rising prices are again linked to growing support for far-right politics in some countries.
Figure 1. In 1923, banknotes in Germany were used as wallpaper because they were worth so little.
(Credit: Bundesarchiv, CC BY-SA 3.0 de)
What is price stability and why does it matter?
What is price stability and why does it matter?
As prices rise during inflation, people can buy less. Families on low or fixed incomes suffer most, as their wages may not rise as quickly. People may spend quickly before prices rise further, which can drive prices up even more. Deflation causes different issues. If people expect prices to keep falling, they may delay spending. Businesses sell less and may cut jobs. So price instability can trigger reinforcing feedback loops that make the problem worse.
Unstable prices create uncertainty for households, businesses, and governments. It becomes harder to plan ahead, repay loans, invest, or provide public services. That’s why price stability is a key goal of state economic policies and central banks, special public institutions that manage a country’s money supply and interest rates to keep the financial system stable.
Figure 2. Inflation of consumer prices
(Credit: Our World in Data, based on IMF data)
How is price stability measured?
How is price stability measured?
The most common measure of price stability is the Consumer Price Index (CPI). It tracks the average price of a ‘basket’ of goods and services over time. If the basket costs £100 this year and £105 next year, inflation is 5%.
Items in the basket are weighted based on household spending (Figure 3). For example, if housing makes up 22% of spending and healthcare 6%, then housing prices affect the CPI more.
But not all experiences are the same. Rural and urban households may face different costs. Some goods, like rent or energy, can rise much faster than others (Figure 4). Some people have the power to demand higher wages to cover the rising prices, but others do not. The CPI also leaves out unpaid care work and homegrown food, and struggles to reflect rapid changes in product quality.
Figure 4. Price changes of various goods in the United States over time.
(Credit: Our World in Data)
Why do price levels change?
Why do price levels change?
To explain inflation and deflation, economists often refer to aggregate demand and aggregate supply. Aggregate demand is the total demand for goods and services in the economy—by households, businesses, and the state—at different price levels. Aggregate supply is the total amount of goods and services that producers are willing and able to offer at different price levels. Prices tend to rise when aggregate demand grows faster than aggregate supply, and may fall when aggregate demand declines.
Two common causes of inflation are:
demand-pull inflation: when aggregate demand increases more quickly than the economy can produce goods and services. This means firms increase their power relative to consumers and may use that power to raise prices.
cost-push inflation: when the costs of producing goods rise due to energy (Figure 5), raw material, or wage increases. It is more costly to produce goods and services, so aggregate supply may decline and businesses may pass on some or all of these higher costs to consumers through increased prices. Their ability to raise prices depends on how much market power they have.
Figure 5. Cost-push inflation is caused by rising production costs, for example when the price of natural gas increased after Russia’s invasion of Ukraine
(Credit: Our World in Data)
Reinforcing loops: when inflation expectations take hold
Reinforcing loops: when inflation expectations take hold
When people expect prices to rise—whether due to media reports, past experiences, or central bank warnings—they may change their behaviour. Consumers might spend more quickly to avoid paying higher prices in the future, workers may demand higher wages, and businesses might increase prices to protect or even increase their profit margins. These behaviours can create reinforcing feedback loops that worsen inflation.
Seller’s inflation has been a concern in recent years. This is when powerful firms take advantage of inflation to increase their profit margins. Economist Isabella Weber explains that during supply shocks such as a war or a pandemic, firms often face higher production costs, which can lead to higher prices. At the same time, news reports about inflation can cause people to expect more price increases. But most people don’t know how much of a price rise is fair. Some large firms have used this uncertainty to raise their prices much more than their rising costs would justify. This happens more often in concentrated markets dominated by a few powerful firms (Section 3.2.4), such as the energy, food, shipping, and defence industries.
Figure 6. Shipping companies increased their profit margins as wars, pandemics, and supply chain disruptions increase their pricing power in this concentrated industry.
(Credit: moofushi, licensed from Adobe Stock)
What are the uses and limitations of current price stability strategies?
What are the uses and limitations of current price stability strategies?
Most states try to manage inflation using monetary policy, particularly by the central bank adjusting interest rates. Interest rates are the cost of borrowing money, expressed as a percentage of the amount borrowed. They also determine how much people earn from savings. When interest rates rise, loans become more expensive and saving becomes more attractive. When interest rates fall, borrowing becomes cheaper and saving is less rewarding.
When inflation is high, central banks become concerned that price expectations will worsen inflation over time. So central banks usually raise interest rates to slow down spending. Higher interest rates make it more expensive to borrow money. Households and businesses take out fewer loans and have less to spend. As a result, aggregate demand decreases (with a delay), helping to ease pressure on prices. When inflation is too low or prices are falling, the central bank lowers interest rates to encourage borrowing and spending. This increases aggregate demand (with a delay), which can help push prices back up and prevent deflation (Figure 7).
Figure 7. The impact of interest rate changes on aggregate demand and aggregate supply.
Note the + and - symbols refer to whether the relationship between the two variables is direct or inverse. The double lines on an arrow indicate a significant delay.
Critics of using interest rates to control inflation are concerned about fairness. Low-income households are hit hardest by rising interest rates. They often have more debt and when interest rates rise, they often see further increases in prices of housing, transport, and credit card debt. They have less financial security. They are also more likely to lose their jobs and suffer from cuts to public services.
Economist Clara Mattei argues that raising interest rates to control inflation acts like austerity (Section 5.2.1), removing support from the most vulnerable and shifting power towards businesses. This makes it harder for workers to demand better wages and allows firms to protect their profits. In this way, current inflation policies reinforce unfair power dynamics in society.
How might a regenerative economy maintain price stability?
How might a regenerative economy maintain price stability?
In a regenerative economy, price stability should support wellbeing, resilience, and fairness. That means reducing inequality, strengthening local systems, and not relying only on interest rates.
Regulating prices and profits during supply shocks
Regulating prices and profits during supply shocks
When firms raise prices much faster than their costs increase, governments may need to step in. Regulation can help stop excessive profits and keep essential goods affordable. One option is strategic price controls, which place temporary limits on how much prices can rise for key items like food, fuel, or rent. Many mainstream economists argue that price controls can discourage production or lead to shortages. But recent research by economist Isabella Weber shows that, in some cases—such as sharp jumps in energy prices—price controls can help manage inflation without damaging the wider economy.
Governments can introduce temporary price controls during crises to keep essential goods like food and fuel affordable. Some economists argue this may lead to shortages if businesses lose price incentives to produce. But recent research by economist Isabella Weber shows that in some cases, such as sharp jumps in energy prices, price controls can help manage inflation without damaging the wider economy.
Windfall taxes are another tool. These are taxes on unexpected, extra-high profits that companies make during a crisis, not because they improved their products or services, but because prices soared. During the 2022 energy crisis, oil and gas companies made record profits simply because prices rose. Taxing these profits can fund support for households or investment in renewable energy (Figure 8).
Competition policies help prevent firms from raising prices unfairly (Section 3.2.4). States may be able to break up monopolies, prevent mergers between large companies that harm competition, and find ways to support smaller businesses. Preventing large firms from having too much pricing power can prevent sellers inflation to support price stability.
Figure 8. Windfall taxes can direct excessive profits from supply shocks back into the economy to help households pay for essentials or other strategies to improve economic resilience.
(Credit: Campact, CC BY-NC 2.0)
Supporting greater independence from markets
Supporting greater independence from markets
One way to reduce the harmful effects of inflation is to ensure that people are not completely dependent on markets to meet their basic needs. Universal basic services, such as free healthcare and transportation, energy allowances, public housing and education reduce the amount of money households must spend. This lowers the impact of inflation on daily life.
State provision of essentials like healthcare, housing, education, and transport reduce people’s need to rely on markets for their basic needs. Universal basic services in these areas make daily life more affordable and reduce the pressure of rising prices.
Commons-based systems also help (Section 4.2.4). Local currencies are used only in one area, so they keep trade and value within the community (Figure 9). This supports local businesses and helps people meet their needs even when prices in the national currency rise. Mutual aid groups help people share skills, goods, or time by offering meals, childcare, or transport or other help. These systems are not just for emergencies. When built in advance, they strengthen communities and reduce dependence on national markets, big companies, and unstable prices. This creates more stability in daily life.
Figure 9. The local Palma currency enables residents of Conjunto Palmeiras to fund projects independently of access to national currency or traditional finance
(Credit: Camille Meyer, original source unknown)
Building resilient networks to avoid or lessen shocks
Building resilient networks to avoid or lessen shocks
When shocks happen, prices often rise quickly. One way to reduce this risk is to build resilient systems that are diverse, distributed, and have built-in backups called redundancy. They don’t rely too heavily on one supplier, one region, or one kind of energy. Instead, they spread risks and can keep going even if part of the system fails.
Relocalisation is one strategy for building resilience (Section 3.4.3 and Section 4.2.3). It means adding local and regional supply chains alongside (or replacing some) global ones, making sure communities aren’t completely dependent on distant systems. For example, growing some food locally can protect people from sudden spikes in global food prices. State investment in local, distributed renewable energy, local repair centres, and public housing also helps. That makes it easier to avoid future shocks that could drive prices up by meeting more basic needs closer to home.
Activity 5.3.6
Activity 5.3.6
Concept: Systems, Regeneration
Skills: Thinking skills (critical thinking, transfer)
Time: varies depending on option
Type: Individual, pairs, or group
Option 1: Monetary policy in a world of supply shocks
Time: 40+ minutes - the time could be shortened if the scenarios were split between groups instead of everyone doing all of them, but then some time is needed for reporting out. The number of scenarios could also be reduced.
In 2024, François Villeroy de Galhau, Governor of the Banque de France, explained that future inflation is likely to be cost-push inflation caused more by supply shocks, climate disasters, war, pandemics, or trade restrictions.
He warned that not all supply shocks should lead central banks to raise interest rates. That’s because interest rate changes often take more than one year to affect price levels in an economy. If a supply shock is short-lived, or caused by factors outside a country’s own economy, then raising interest rates may not help. It could even make the situation worse, by raising borrowing costs for people and businesses when they’re already struggling.
To help think clearly about this, he explained that central bankers could use a ‘map’ to understand different kinds of supply shocks, with five key features (Figure 10).
Step 1: Understand the five features
Individually, with a partner or small group, review the five features of supply shocks. Make sure you understand what each one means. Try to think of one real or imagined example for each feature.
Step 2: Explore five scenarios
Now read the following supply shock scenarios. For each one:
Identify how it scores on the five features (short time or long time? inside or outside? etc.)
Decide whether the shock is more or less likely to cause serious inflation
Decide whether raising interest rates is likely to help or not and explain why, using the various factors from the map
Suggest one other policy that might work better in this case
Scenarios
A major flood destroys roads and farmland in your country, cutting off local food supply. Recovery will take months.
A pandemic causes factory shutdowns in Asia, delaying imports of electronics for a few weeks.
Your government introduces a new carbon tax without giving businesses time to prepare. Energy prices rise quickly.
A war in a nearby region disrupts oil supply across Europe. Energy prices rise sharply for several months.
A new international shipping route opens, suddenly making food imports cheaper and more available.
Option 2: Price stability in your context
Time: 40+ minutes, depending on whether students are given sources, and whether the activity is extended to speak with other adults impacted by inflation
Most countries experienced rising inflation during and after the COVID-19 pandemic. You will explore how inflation has developed in your country, and examine how the media presents it. You'll practise identifying whether inflation is explained as demand-pull or cost-push (supply-side), and reflect on the types of policies used in response.
Step 1: Choose one of these research options
Option A: Find recent inflation data for your country using a trusted source (such as your national statistics office or central bank).
Option B: Find a recent article or news story about inflation in your country (or another country if more relevant). Print or save a copy if possible.
Step 2: Answer these questions individually, in pairs, or a small group
What is the current rate of inflation? How has it changed over the past 3–5 years?
What explanation is given for the inflation?
Is it described as demand-pull inflation (caused by too much spending or demand)?
Or as cost-push inflation (caused by higher production costs, supply shortages, or global shocks)?
Who or what is blamed for rising prices?
What policies are mentioned in response to inflation?
Is the central bank raising interest rates or using other tools?
Are any other policies mentioned to address the effects of inflation (such as changes in taxes, price controls, or support for affected groups)?
Does the article present these policies in a positive, negative, or neutral way? Why do you think that is?
Step 3 (Optional): Extend the activity
Interview an adult (e.g. a family member or neighbour) about how inflation has affected their daily life. What changes have they noticed in prices, wages, or budgeting?
Invite a guest speaker who has lived through hyperinflation or severe price instability to speak to your class. Prepare respectful and thoughtful questions in advance.
Option 3: Indexed data
Time: 20 minutes
Inflation is often shown using index numbers, such as the Consumer Price Index (CPI). Index numbers don’t show actual prices. They show how prices have changed compared to a base year (usually set as 100).
Step 1: Learn how an index works
An index starts from a base year, which is given a value of 100.
If the index rises to 110, that means prices have increased by 10% compared to the base year.
If it falls to 95, that means prices have decreased by 5% since the base year.
Consider this information:
Year Consumer Price Index (CPI)
2020 100
2021 105
2022 112
2023 120
Step 2: Answer these questions individually, in pairs or a small group
By what percentage did prices rise from 2020 to 2023?
Which year saw the biggest increase in inflation? How do you know? (Note: here is an opportunity to practice calculating percentage change)
Option 4: Diagramming inflation feedback loops
Time: 25 minutes
The text explained that inflation expectations can create reinforcing feedback loops related to aggregate demand, wages, and seller’s inflation that make inflation worse. In this activity, you will draw three causal loop diagrams, each showing a different way that inflation expectations can lead to actual price increases.
Note: You need to be familiar with causal loops and feedback from Section S.5 before doing this activity. Section S.9 on systems traps is also useful, because each of these is a form of the escalation system trap.
For each of the following causal loop diagrams:
Identify the parts/variables (aim for 3)
Identify the relationships between the parts. Draw a + to indicate a direct relationship, and a - to indicate an inverse relationship
Indicate the type of feedback involved: reinforcing (R) or balancing (B)
The consumer spending loop
2. The wage-price spiral
3. Seller’s inflation
These relationships might not hold true under certain conditions. With a partner if possible, discuss what would happen if:
Price levels increased so much that the value of workers wages was significantly harmed. They can’t afford to buy much.
Workers do not have bargaining power, for example there are no or only very few or weak unions.
Sellers decide not to use their pricing power to raise prices.
Ideas for longer activities and projects are listed in Subtopic 5.5
Checking for understanding
Checking for understanding
Coming soon!
Further exploration
Further exploration
Inflation - A BBC Bitesize with the basics of inflation. Difficulty level: easy
What is inflation? - A simple explainer from the Bank of England, the UK central bank. Difficulty level: easy.
Inflation and its measurement – An article from the Reserve Bank of Australia explaining how the CPI ‘basket’ is chosen and why it matters for measuring inflation. Difficulty level: medium.
As NZ workers and households tighten their belts, why not a windfall tax on corporate mega-profits too? – An article in The Conversation by Professor Lisa Marriott for The Conversation exploring what windfall taxes are, when they have been used in the past, and whether they are effective. Includes examples from New Zealand, the UK, and the US.Difficulty level: medium.
Seller’s Inflation - A short video from the Institute for New Economic Thinking (INET) and economist Isabella Weber about how firms used supply shocks and news stories to justify raising prices more than their costs, worsening inflation in recent years. Difficulty level: medium
How outsized corporate profits raised prices – A podcast episode from Pitchfork Economics with Lindsay Owens, Executive Director of the Groundwork Collaborative, explaining how large companies took advantage of crises to raise prices beyond their rising costs. Difficulty level: high.
Sources
Sources
Bank of England. (n.d.). What is inflation? https://www.bankofengland.co.uk/knowledgebank/what-is-inflation
Statistisches Bundesamt (Destatis). (2023, February 22). Verbraucherpreisindex für Deutschland / Consumer price index for Germany: Wägungsschema für das Basisjahr 2020 / Weighting pattern for base year 2020. https://www.destatis.de/kontakt
Carter, Z. (2023, June 5). What if we’re thinking about inflation all wrong? The New Yorker. https://www.newyorker.com/magazine/2023/06/05/what-if-were-thinking-about-inflation-all-wrong
Hannon, Paul (May 3, 2023, May 3). Why Is Inflation So Sticky? It Could Be Corporate Profits. The Wall Street Journal. https://www.wsj.com/economy/why-is-inflation-so-sticky-it-could-be-corporate-profits-b78d90b7
Mattei, C. (2022). The capital order: How economists invented austerity and paved the way to fascism. University of Chicago Press.
Our World in Data. (n.d.). Inflation of consumer prices. International Monetary Fund (via World Bank), World Development Indicators. https://ourworldindata.org/grapher/inflation-of-consumer-prices
Raworth, K. (2017). Doughnut economics: seven ways to think like a 21st century economist. London: Penguin Random House.
Reardon, J. (2018). Introducing a new economics: Pluralist, sustainable, & progressive. London: Pluto Press.
Reserve Bank of Australia. (n.d.). Inflation and its measurement. https://www.rba.gov.au/education/resources/explainers/inflation-and-its-measurement.html
van Staveren, I. (2015). Economics after the crisis: An introduction to economics from a pluralist and global perspective. Routledge.
Villeroy de Galhau, F. (2024, October 30). Monetary policy in perspective (II): Three landmarks for a future of “Great volatility”. Banque de France. https://www.banque-france.fr/en/governors-interventions/monetary-policy-perspective-ii-three-landmarks-future-great-volatility
Weber, I. (2022, January 3). We need to control prices now – it’s the best way to avoid runaway inflation. The Guardian. https://www.theguardian.com/commentisfree/2022/jan/03/price-controls-inflation-pandemic
Weber, I. (2025, 14. February). Der freie Markt gefährdet unsere Zukunft: Wenn Katastrophen die beste Zeit für Unternehmensgewinne sind, gibt es wenig Hoffnung für die Zukunft. Surplus. https://www.surplus.online/policy/weber-the-free-market-endangers-our-future
Terminology (in order of appearance)
Terminology (in order of appearance)
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