What Is Inflation?
Inflation is the rate at which prices for goods and services rise over time, reducing purchasing power. If inflation is 3%, something costing $100 today would cost $103 next year. Moderate inflation (2-3%) is normal in healthy economies. High inflation erodes savings and wages; deflation (falling prices) can cause economic stagnation. Central banks try to maintain stable, low inflation.
Key Takeaways
- Inflation occurs when too much money chases too few goods.
- Hyperinflation (extremely high rates) can make currency nearly worthless - Zimbabwe and Venezuela are recent examples.
- Deflation sounds good but discourages spending (why buy today if it is cheaper tomorrow?
Explanation
Inflation occurs when too much money chases too few goods. Causes include: demand-pull (strong consumer demand), cost-push (rising production costs like oil or wages), and monetary factors (central banks printing money). Supply chain disruptions, energy price shocks, and government spending can all contribute to inflation.
Inflation is measured using indexes like the Consumer Price Index (CPI), which tracks prices of a basket of common goods and services. Core inflation excludes volatile food and energy prices for a clearer trend. Different people experience inflation differently based on what they buy - housing, healthcare, and education often rise faster than overall inflation.
Effects of inflation include: savings losing value (money in a bank earning 1% interest loses purchasing power at 3% inflation), benefiting borrowers (loan repayments are made with less valuable dollars), and hurting people on fixed incomes. Wages often lag behind inflation, temporarily reducing purchasing power until they catch up.
Things to Know
- Hyperinflation (extremely high rates) can make currency nearly worthless - Zimbabwe and Venezuela are recent examples.
- Deflation sounds good but discourages spending (why buy today if it is cheaper tomorrow?) and can spiral into depression.
- Inflation rates vary significantly by country based on their monetary policy and economic conditions.