Inflation is a sustained increase in the general price level of goods and services in an economy. As prices rise, a unit of money purchases fewer goods and services: its purchasing power declines. Inflation concerns a broad collection of prices, rather than an increase in one product’s price alone. A central subject of macroeconomics, it is usually expressed as the percentage change in a price index over a specified period, most commonly a year.
Measurement
The consumer price index (CPI) measures changes in prices paid by consumers, using expenditure weights to combine prices across categories such as food, housing, transport, and services. Coverage, weighting, and treatment of housing differ between countries. Statistical agencies periodically update expenditure patterns and account for changes in product quality.
If a price index rises from 120 to 126 over a year, annual inflation is:
An index’s numerical level depends on its reference period; its percentage change measures inflation. Monthly and annual rates describe different intervals, while annualized monthly rates extrapolate a short-term change rather than report an observed full-year increase.
The GDP deflator, derived from nominal and real gross domestic product, covers domestically produced final goods and services. Unlike consumer indices, it includes investment and government output but excludes imports directly. Producer price indices measure prices received by producers and can help track upstream pressures.
Core inflation measures seek to identify underlying price trends. A common approach excludes food and energy because their prices can be volatile; other approaches trim unusually large price movements. Headline inflation includes all categories. Neither measure captures every household’s experience, because spending patterns differ.
Related concepts
Deflation is a decline in the general price level. Disinflation is a reduction in the inflation rate: prices can continue rising, but more slowly. A fall from 8 percent inflation to 3 percent therefore does not mean that earlier price increases have been reversed.
Relative price changes concern one good’s price compared with others. An isolated shortage can raise a particular price without generating persistent economy-wide inflation. Nevertheless, a major increase in widely used inputs can affect many prices simultaneously.
Inflation is cumulative. If prices rise by 5 percent in each of two consecutive years, the total increase is 10.25 percent, not exactly 10 percent.
Causes and propagation
Inflation can emerge through interacting changes in supply and demand, production capacity, monetary conditions, and expectations.
Demand-driven inflation occurs when aggregate spending expands faster than an economy’s capacity to supply goods and services. Strong consumption, investment, or government expenditure can create pressure when labor and equipment are already heavily utilized.
Supply-driven inflation can follow higher input costs, disrupted production, poor harvests, or reduced productive capacity. Its persistence depends on subsequent wage adjustments, spending, expectations, and policy responses. Improvements in productivity can moderate cost pressures by increasing output per unit of input.
The relationship between the money supply and prices is often discussed through the quantity theory of money. Its familiar expression, , relates money, its velocity of circulation, the price level, and real output. The accounting relationship alone does not establish causation: velocity, output, credit conditions, and money demand can change. Sustained monetary expansion relative to real output growth can support persistent inflation, but money growth and consumer inflation need not move together over short periods.
International trade transmits price changes across borders. A depreciating exchange rate can increase domestic import costs, although the extent and timing of pass-through vary.
Inflation expectations influence wage bargaining, price setting, and financial contracts. Anticipated price increases may become embedded in recurring adjustments. Wage growth, however, need not be inflationary when matched by productivity growth.
Economic effects
Inflation reduces purchasing power when nominal incomes fail to keep pace. Its distributional effects depend on spending patterns, income adjustments, assets, and liabilities. Households spending large shares on rapidly rising necessities may experience inflation above the published average.
Unexpected inflation generally benefits borrowers with fixed nominal debts and disadvantages their creditors, because repayments have lower purchasing power than anticipated. Indexed contracts and variable interest rates alter this effect.
High or unpredictable inflation can obscure relative price signals, complicate planning, and increase the frequency of repricing. Nominal tax thresholds can also change effective tax burdens unless adjusted.
The relationship between inflation and conditions in the labor market is often analyzed through the Phillips curve. Short-run relationships depend on expectations and supply shocks; there is no stable, universally exploitable long-run trade-off between inflation and unemployment.
Hyperinflation denotes exceptionally rapid inflation, conventionally beginning when monthly price increases exceed 50 percent. Such episodes can undermine monetary exchange and are often associated with severe fiscal and monetary instability.
Policy responses
A central bank uses monetary policy to influence spending, financial conditions, and expectations. Raising the policy interest rate generally restrains borrowing and demand, although transmission occurs with variable lags and may reduce output and employment temporarily.
Under inflation targeting, authorities announce an inflation objective and explain policy decisions in relation to it. Many advanced-economy central banks target approximately 2 percent, though measures and frameworks differ.
Fiscal policy also affects demand through taxation and public expenditure. Supply-side measures may alleviate bottlenecks, but their effects depend on implementation and timing. Price controls can suppress recorded prices temporarily; when ceilings are binding, they may also produce shortages, rationing, or reduced supply without removing the underlying inflationary pressures.