The inflation rate is the average annual change in prices that consumers see reflected on store shelves. The rate of inflation is determined by how, where and when new money enters the economy. This process increases the general price level, but it also distorts relative prices and wages, as well as rates of return on investments.
Inflation occurs when the amount of money circulating in an economy exceeds the growth in the overall economy’s output. Generally speaking, governments and central banks target a modest inflation rate, which keeps the purchasing power of consumers steady. Consumers often respond to this with increased spending, which in turn helps boost the economy and business profits. However, when inflation becomes out of control, the effect is more severe and may lead to higher interest rates on loans and mortgages, as well as a slowing economy.
Some types of inflation are considered good, such as demand-pull inflation. This type of inflation is caused by a surge in demand for goods and services due to economic factors, such as low unemployment or an increase in government spending. However, this inflation can also stretch resources and lead to supply chain disruptions, which in turn drive up prices for consumers.
High inflation is generally viewed negatively, as it can devalue the purchasing power of people’s savings and salaries. Additionally, it makes it difficult to save for future needs or invest in stocks and bonds. Inflation can also make a country uncompetitive, as prices for products may rise faster than the country’s wages and other costs of production. For this reason, many statistical agencies report a measure of core inflation, which excludes volatile food and energy prices to more accurately detect longer-term trends in prices.