An inflation rate is the average change in the prices of a basket of economic goods and services purchased by consumers. It’s often used to measure price changes in a country, but can also be applied at the sector or even company level. The most commonly known index for measuring inflation is the Consumer Price Index (CPI), though economists can also use other measures of prices like the Personal Consumption Expenditures (PCE) index to see how consumers’ purchasing power is changing in a country.
While it’s sometimes used loosely to describe any increase in prices, inflation actually refers to a particular type of price growth that’s a result of a central bank creating more money than the public wants to hold. This relative-price pressure passes through to all prices and wages, causing inflation.
A rise in relative prices can erode household purchasing power, leading to belt-tightening and growing pessimism about the economy. It can also lead companies to raise their own prices in an attempt to offset their increased costs. Ideally, companies will strike a balance between raising their prices to cover input costs and keeping those prices low enough that their customers can afford them.
Generally, high and volatile inflation rates are considered harmful to a country’s economy. They make it harder for businesses to plan long-term, and can create uncertainty about the purchasing power of currency. A steady, moderate rate of inflation, on the other hand, can help businesses and individuals make sound decisions about saving, investing, and borrowing, contributing to a healthy economy.