Inflation is a sustained increase in the general level of prices for goods and services over time. When inflation is positive, each unit of currency buys a little less than it did before — economists say the purchasing power of money falls.
How inflation is measured
Governments and statistical agencies track inflation using price indexes. The best known is the Consumer Price Index (CPI), which follows the price of a representative "basket" of everyday goods and services — food, housing, transport, healthcare and more. The annual percentage change in the index is reported as the inflation rate.
What causes inflation?
Economists commonly describe two broad forces. Demand-pull inflation happens when spending grows faster than the economy's ability to produce, bidding prices up. Cost-push inflation happens when the costs of production rise — for example, more expensive energy or raw materials — and businesses pass those costs on. Expectations matter too: if people expect prices to rise, workers may seek higher wages and firms may raise prices pre-emptively, which can reinforce the cycle.
Why central banks target low, stable inflation
Most central banks in advanced economies aim for low and stable inflation — commonly around two percent a year — rather than zero. A little inflation gives policymakers room to cut interest rates in downturns and helps wages and prices adjust. High or unpredictable inflation, by contrast, erodes savings, distorts investment decisions and tends to hurt people on fixed incomes most.
Inflation and everyday life
Inflation affects savers, borrowers, workers and retirees differently. Savings held as cash lose purchasing power over time, while borrowers can benefit because they repay loans in money that is worth less. This is why financial planning usually considers inflation when comparing returns on savings and investments.
This article is general educational information, not financial advice.