A nation’s inflation rate is a measure of how fast prices are rising, which reduces the purchasing power of currency. The federal Bureau of Labor Statistics calculates the annual rate by monitoring price changes to a basket of goods and services purchased by households on average, including food, clothing, housing, transportation, medical care, recreation, and communication. Policymakers and financial market participants typically focus on core inflation, which excludes the prices of food and energy to provide a more accurate picture of everyday living expenses.
Inflation can be beneficial, but it also can be dangerous and create a wide range of problems, from higher interest rates to a loss of purchasing power. It can make the value of savings erode, which discourages investment, and it can wreak havoc on people’s budgets and businesses’ costs, resulting in higher unemployment. It can also be a problem for those with lower incomes, who spend a larger portion of their budget on things like food and gas, which can see prices spike unexpectedly and leave them less wealthy than they were when they started spending money.
Inflation is a complex phenomenon, but it can generally be attributed to too much money chasing too few goods. This can be triggered by demand shocks (e.g. the COVID-19 pandemic), supply chain bottlenecks, emergency government spending, or even war. It can also be caused by a shortage of consumer goods or other factors beyond the control of government, such as natural disasters. Expectations can also play a role: if people anticipate future inflation, they will factor that into wage negotiations and contractual price increases and this can cause an inflation spiral.
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