Inflation is the gradual increase in the general level of prices for goods and services in an economy over time. When inflation occurs, each unit of currency buys fewer goods and services than before. In other words, purchasing power decreases.
Inflation is a normal feature of most modern economies. Moderate inflation is generally seen as a sign of a growing economy, while very high or very low inflation can cause problems.
How inflation works
Inflation doesn’t mean that all prices rise at the same time or by the same amount. Instead, it reflects an overall trend across the economy.
For example:
- If inflation is 3% per year, something that costs $100 today will cost about $103 next year.
- Your money hasn’t changed, but what it can buy has.
Inflation is usually measured as an annual percentage change.
What causes inflation?
Economists generally group the causes of inflation into three main categories.
Demand-pull inflation
This happens when demand for goods and services grows faster than the economy’s ability to produce them.
Common drivers include:
- Rising consumer spending
- Government stimulus or increased public spending
- Rapid population or income growth
When too many dollars chase too few goods, prices tend to rise.
Cost-push inflation
Cost-push inflation occurs when the cost of producing goods and services increases, and businesses pass those costs on to consumers.
Examples include:
- Higher wages
- Increased raw material or energy costs
- Supply chain disruptions
Even if demand stays the same, higher production costs can push prices up.
Built-in inflation
Built-in inflation is linked to expectations.
If workers expect prices to rise, they may demand higher wages. Businesses then raise prices to cover higher wages, reinforcing inflation. This cycle is sometimes called a wage–price spiral.
How is inflation measured?
Inflation is typically measured using price indexes that track the cost of a basket of commonly purchased goods and services over time.
Common measures include:
- Consumer Price Index (CPI): Measures price changes faced by consumers
- Producer Price Index (PPI): Measures price changes faced by producers
These indexes help governments, businesses, and individuals understand how prices are changing.
Is inflation good or bad?
Inflation isn’t inherently good or bad, it simply depends on the rate of inflation.
- Low and stable inflation encourages spending and investment
- High inflation erodes savings and creates uncertainty
- Deflation (falling prices) can discourage spending and slow economic growth
Most central banks aim for a small, predictable inflation rate to keep the economy stable.
How does inflation affect you?
Inflation impacts everyday life in several ways:
- Cost of living: Essentials like food, housing, and transportation may become more expensive
- Savings: Money saved today may be worth less in the future
- Wages: If wages don’t rise as fast as prices, real income falls
- Debt: Inflation can reduce the real value of fixed-rate debt
Understanding inflation helps individuals make better decisions about spending, saving, and investing.
Inflation means that over time, money loses some of its buying power. Prices tend to go up, not because businesses are greedy, but because of how demand, costs, and expectations interact across the economy.
A little inflation is normal. Too much, or too little, can be a problem.
