The inflation rate is the average annual percentage change in prices paid by urban consumers as reported by the Bureau of Labor Statistics (there are many different price indexes). It’s a key economic indicator used by governments, business leaders and consumers to understand broader price movements.
Inflation happens when the supply of money in an economy outpaces the economy’s ability to produce goods and services at a reasonable cost. As a result, one unit of currency loses purchasing power over time, which hurts people’s pocketbooks. It can also negatively affect long-term economic growth.
There are many reasons why prices might increase, such as when there is a surge in government spending or when companies have to pay more for their raw materials, which causes them to raise prices for end users, based on the basic economic principle of supply and demand. This is called demand-pull inflation.
There are other ways that inflation can play out, including when the central bank intentionally increases inflation to stimulate an economy. This is known as reflation and is done by reducing interest rates, which makes it more affordable for businesses and consumers to borrow money. The other way that inflation can play out is when it’s not managed and ends up getting out of control. This is called hyperinflation and is when the rate of price increase is well above 10% per year. It can be a serious threat to a country’s financial system and cause widespread discontent among the population.