Inflation is the general rise in prices across an economy. It can affect people’s purchasing power, slow economic growth, and raise or lower interest rates on national debt. Understanding and properly managing inflation is one key element to promoting a healthy, sustainable economy.
The modern definition of inflation was established in the 1960s after decades of debate. Today, economists almost universally agree that any increase in the price of goods and services that affects most households is a form of inflation. Individual spending habits determine how much weight a particular product or service has in the overall calculation, which is often called the Consumer Price Index (CPI).
A CPI is comprised of 8 different categories of goods and services that most households purchase, such as food, transportation, clothing, and housing. Each item in the basket is measured and compared to its price from the same time period last year. The average of the weighted items makes up the annual rate of inflation.
Most of the current inflation is thought to stem from a combination of demand-pull factors such as high consumer demand, and supply chain disruptions from the COVID-19 pandemic and subsequent oil and commodity price spikes. The low level of production is also driving price increases, as labor shortages and a lack of raw materials push prices higher.
Some economists have made maintaining low and stable inflation a primary policy objective, a practice known as Inflation Targeting. Low, stable and predictable inflation can be beneficial to an economy by giving consumers a better idea of future prices and increasing their incentive to make purchases sooner. Inflation can also be beneficial to individuals with tangible assets priced in their home currency, such as property or stocked commodities, by raising their prices over time.