The inflation rate is the overall increase in the prices of a basket of goods and services over time. It is an economic phenomenon that reduces the purchasing power of money and can have serious consequences for people, companies, and governments. Understanding how inflation works is an essential part of financial literacy and can help you better manage your finances.
Inflation is a phenomenon that occurs when the supply of money in an economy exceeds the demand for it. This disparity results in a general rise in prices and costs as the new money makes its way from hand to hand and account to account in the economy, driving up some prices and rates of return first before affecting others later.
This type of inflation is typically driven by supply-side factors, including increased monetary policy, higher raw materials prices, labor mismatches, and supply disruptions. During the COVID-19 pandemic, for example, industrial producers were forced to raise prices for end consumers as they faced rising input costs and labor shortages.
When determining an inflation rate, statistical agencies look at the price changes of what is known as a “basket” of goods and services consumed by households. This basket is made up of many items, and each item’s price change is weighted according to the amount that householders actually purchase from each good or service. These weighted changes are then compared to the prices of the same basket in a previous period to determine the rate of inflation.