Welcome! Today we'll explore inflation, one of the most important economic concepts. Inflation is the rate at which the general level of prices for goods and services rises over time. When inflation occurs, each unit of currency buys fewer goods and services than before.
The key consequence of inflation is the decline in purchasing power. Imagine you have one hundred dollars in 2020. With that money, you could buy five items. But due to inflation, by 2024, the same one hundred dollars might only buy three items. Your money hasn't changed, but its purchasing power has decreased.
Inflation has several main causes. Demand-pull inflation occurs when there's too much demand for goods and services compared to supply. Cost-push inflation happens when production costs rise, forcing companies to increase prices. Monetary inflation results from too much money in circulation, making each dollar worth less. All these factors can work together to drive prices higher.
Inflation is measured using the Consumer Price Index, or CPI, which tracks the prices of a basket of common goods and services. The inflation rate is expressed as an annual percentage. For example, a three percent inflation rate means prices have increased by three percent compared to the previous year. Central banks often target around two percent inflation as healthy for the economy.
Inflation has significant economic impacts. While it reduces purchasing power and affects savings, moderate inflation can stimulate economic growth. Central banks control inflation primarily through monetary policy, especially by adjusting interest rates. Higher interest rates typically reduce inflation by making borrowing more expensive and saving more attractive. Understanding inflation helps us make better financial decisions and understand economic policy.