Inflation in EU2 is a factor which makes almost everything more expensive.
Scope of Inflation
Each country has its own inflation level, and countries' inflation levels are entirely independent of each other. Inflation starts at 1.0 for most countries in most scenarios, with a few exceptions.
Inflation cannot go lower than 1.0; any decrease in inflation that would take it below 1.0 instead sets it to 1.0. Inflation can easily go higher; it has no upper bound.
Inflation in the game is usually given in percentage points, which are each 0.01 inflation. Thus, in the "corruption" random event you must choose either a point of inflation, or to lose 100d. If you choose the inflation and your inflation is currently 1.05, it goes to 1.06. By convention, inflation levels for countries are always written as percentage points above 1.0; thus, when a country's inflation is 1.41, it has 41% inflation.
You can see your country's inflation level on the financial summary screen; it is at the very bottom. Inflation is displayed as points above 1.0; so, if your country's inflation is 1.21, the display would show 21%.
Effect of Inflation
Inflation acts as a multiplier on the cost of practically everything in the game: armies, navies, tech, stability, tax collectors, missionaries, manufacturies, etc. For example, the base cost of a tax collector is 50d; if your country has 16% inflation, each tax collector will cost 58d. (50d * 1.16 = 58d)
The only cost that is not altered by inflation is making peace; there, 25 ducats buys 1% warscore regardless of inflation levels in the two countries.
Thus, one effect of inflation is that it in effect decreases your current cash balance. If you have built up 1000 ducats in your treasury, and you mint for a year, then your warchest buys approximately 1% less than it did before, i.e., it is worth 990 of the pre-inflation ducats.
The primary cause of inflation in the game is minting, that is, directing monthly income to the treasury. If you mint 100% of your monthly income for a month, then that income is turned into ducats in your cash balance. At the same time, you get 1/12 point of inflation (0.000833 inflation). If you mint less than 100%, you get a proportionate fractional reduction in both the amount of ducats you get, and the amount of inflation you suffer. You can see the projected effect of minting, by setting the Treasury slider then mousing over it. The tooltip will show how much income is projected, and how much minting-based inflation, as well as how much gold inflation (see below).
Another cause of inflation for many countries is controlling gold provinces. If a country's gold income exceeds 40% of a particular subset of its monthly income, it will get so-called gold inflation. This works as follows:
x = gold_income / (gold_income + production_income + taxation + trading_income) gold_inflation=0 if x < 0.40 gold_inflation=x/4.0 if x >= 0.40
Taxation is given on page 9 of the ledger. Taxation is the sum of province taxes plus looting income. Thus, if you are getting gold inflation, the only way to lower it is to get more production income, trade income, province taxes, or loot. No other source of income will reduce gold inflation; census taxes, peace resolution, events, tolls, trade tariffs, and income from vassals do not affect gold inflation.
The actual impact of gold inflation occurs on each January 1. The total amount of the various income types are summed for the entire year; so it makes no difference what month or months looting_income is derived. The financial summary screen gives only a clue as to the actual gold inflation that may occur. It tells only what gold inflation might be considering only the income amounts of the previous month. The mouse-over tooltip for the "To Treasury" slider on the budget screen gives a better estimation of gold inflation. Still, the mouse-over tooltip is also imprecise; it only tells what the gold inflation would be considering all the income computed thus far for the year; December's influence can never be seen.
During January, gold inflation always reads 0.00% in the financial summary screen and mouse-over tooltip for the treasury slider. There has been no income for the calculation at that time. Saving and reloading never impacts gold inflation, since the relevant cumulative incomes for the year are stored in the save game. Even though the financial summary screen always shows 0.00% after a reload, the mouse-over tooltip for the treasury slider gives the gold inflation as it would otherwise be displayed without a save and reload.
There are several other ways to get inflation. War taxes cause, among other effects, +1% inflation. Some random events, such as the corruption event, can cause inflation. There are also particular scripted events for some countries which cause inflation, such as the Spanish Bankruptcy Events that Spain gets if it is successful in owning gold provinces in the New World. Finally, bankruptcy causes severe inflation.
Inflation is quite hard to get rid of. Early in the game the only way to reduce inflation is the "exceptional year" random event, which subtracts 2 points of inflation. But this is a random event. Getting one or two per century is about average; getting none in a century is quite common. Starting in 1600, "deflation" random events become active which can reduce inflation by 5 points, and then later even more random events (bank, stock exchange) may happen if you have infra tech 7 and, for "stock exchange", trade 9.
When you get to infrastructure 5, you can promote governors; each governor reduces inflation by 0.25 points per year, divided by the number of cities you own. Thus if you have promoted governors in every city you own, your inflation will decline 0.25 in a year in which you do not mint at all. Unfortunately, governors are not cheap.
In summary, although inflation is not exactly forever, it is close. And thus, in general, you can think of inflation as "costing" you based by reducing not just your current cash balance, but also reducing all the income you are going to get for the entire rest of the game. That's why high inflation can be so crippling.
It is often the case that the money you spend can provide a return on investment that more than offsets the inflation caused by the minting required to get it. This is always the case with tax collectors, governors and judges (in that order), usually with merchants (especially with high mercantilism), while with manufactories and colonies it can go either way. Thus even while you are running 50% inflation if you increased your income by 200% you are managing your economy very successfully.
An less obvious method to reduce the effect of inflation is that ideally only during peacetime with high stability should you be doing your minting. Since minting gets you a flat 0.1% inflation per month, you should try to get as much out of it as you can. Stockpile enough money to run your expenses for ten years or more. Then during the wars when blockades, pillaging, war exhaustion, and other factors erode your income you can spend everything on tech.