Inflation refers to the rate at which the general level of prices for goods and services in an economy rises over time, resulting in a decrease in purchasing power of a unit of currency. In simpler terms, it means that as inflation occurs, the purchasing power of money decreases because you can buy fewer goods or services with the same amount of money.
Inflation is usually measured using various economic indicators, such as the Consumer Price Index (CPI) or the Producer Price Index (PPI), which track the changes in prices of a basket of goods and services over time. Inflation can have significant impacts on individuals, businesses, and economies, as it affects the cost of living, savings, investment, and economic planning.
There are several causes of inflation, including demand-pull inflation, cost-push inflation, built-in inflation, and structural inflation. Demand-pull inflation occurs when there is an increase in demand for goods and services relative to their supply, causing prices to rise. Cost-push inflation occurs when the production costs of goods and services increase, such as when there is an increase in wages or raw material prices, leading to higher prices for end products. Built-in inflation occurs when there are expectations of future price increases, leading to higher wages and prices to compensate. Structural inflation can occur due to changes in the structure of an economy, such as shifts in supply or demand, changes in government policies, or changes in market conditions.
Central banks and governments often implement monetary and fiscal policies to manage inflation. For example, central banks may use tools such as interest rate adjustments or open market operations to influence the money supply and control inflation. Governments may use fiscal policies such as taxation or spending to influence demand and manage inflation. Managing inflation is an important aspect of macroeconomic policy, as both high inflation and deflation (falling prices) can have negative consequences for an economy. Central banks and policymakers aim to achieve a stable and moderate level of inflation that supports economic growth and stability.