A little bit of inflation is good, helping businesses to keep expanding and bumping up workers’ paychecks. Too much, though, is a big problem, making it hard for people to afford goods and services and eroding the purchasing power of savings and investments.
Inflation is the percentage change in the prices of a basket of consumer goods and services in an economy. The rate is calculated by comparing the price of the basket to a base year and then measuring the percent change in that price level over time. A high rate of inflation is usually accompanied by higher unemployment and slower economic growth.
The most common measure of inflation is the Consumer Price Index, or CPI. It tracks the prices paid by urban consumers for a set of consumer goods and services—including coffee, shoes, and hospital care. The index uses a weighted system to give more weight to things like food and housing than, say, recreation. In addition to the headline CPI, there’s also a core measure of inflation that excludes the more volatile items that tend to fluctuate more than others.
The main causes of inflation are cost-push and demand-pull factors. The former occurs when the price of raw materials or labor rises, and companies pass those increased costs on to customers. The latter is often the result of supply-side shocks, such as natural disasters or war that restrict production capacities. If the causes are combined—as they were in the 1970s, when an OPEC oil embargo prompted by Israel’s Yom Kippur War led to stagflation—the effect is sometimes called runaway inflation.
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