Inflation is the rate of ongoing increases in prices across a wide range of products and services. The concept is most easily understood when comparing the prices of the same goods and services over time. If they cost $100 this year and $105 next, that’s an increase in price of 5%—that’s inflation.
At a more general level, a low and stable rate of inflation is generally considered desirable. It means that the economy is growing quickly enough that new money created through monetary policy can be circulated and used to increase prices, wages, and rates of return in a relatively gradual way.
But when the rate of inflation is too high, it can cause major problems. Consumers may experience higher bills for everything from groceries to utilities to gas. Increasing costs can lead to household belt tightening and pessimism about the economic outlook. Business executives face a more complicated challenge as they seek to balance their desire to protect margins with the need to pass along price increases to customers.
A high inflation rate can make a country uncompetitive, as it makes its products less affordable to buyers around the world. It can also discourage investment, as investors will seek a safe haven in assets such as cash and stocks that are not likely to lose value over the long term. This is why a government’s central bank usually has an eye on the inflation rate as it formulates its monetary policy.
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