What Is Inflation?

Understanding economics can help you make better financial decisions, but coming to grips with economic jargon can be a real headache. Inflation is a concept that often confuses consumers, and yet it affects how much we pay for essentials like food, fuel and healthcare.

Inflation: Defined

In the simplest terms, inflation is a decline in what you can buy for your money. Inflation measures how quickly a currency's value falls against increases in the cost of living. Conversely, deflation happens when a currency's value increases and the cost of living declines.

Experts can estimate inflation rates by measuring how much certain products and services increase in price to track the purchasing power of a particular currency. These commodities could include food products, electricity, gas, leisure activities and healthcare services. Various indexes track the inflation rate, including the Consumer Price Index and the Wholesale Price Index.

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What Causes Inflation?

Inflation occurs when an oversupply of money causes the price of commodities to rise. There are various economic reasons for an increase in money supply:

• Authorities printing and distributing more money
• Reducing the value of a currency through legal means
• Creating new money by distributing loans through government bond purchases

Financial regulators use various methods to keep inflation steady and manageable. This makes it easier for companies and individuals to make financial plans. For example, authorities might control interest rates to prevent massive inflation during an economic crisis.

Is Inflation Good or Bad?

There are pros and cons to inflation, depending on your situation and viewpoint. A steady, sustainable inflation rate can help stimulate the economy because it encourages companies and individuals to spend on goods and services instead of saving. However, unpredictable or steep inflation rates can make it difficult to predict future purchasing power, potentially leading to economic damage.

High inflation rates can cause problems for consumers if their wages don't increase in proportion to higher living costs. People with assets (like homes) to sell may benefit from moderate inflation because it increases the value of their assets, allowing them to sell for a higher price. However, people hoping to buy assets fare worse during periods of higher inflation because they have to pay more.