Definition of inflation

Inflation is a general increase in prices, normally expressed as the annual rate of growth in the consumer price index (CPI) or retail price index (RPI) – measures of the inflation rate. One can also measure inflation in producer or wholesale price terms. Unless matched by an increase in wages, inflation means a loss of purchasing power for the consumer. It also reduces the value of a country's currency, as more units of currency are needed over time to buy the same goods.

Inflation is the result of too much purchasing power competing for too few goods and services. Here, Ben Bernanke seeks to offset the effects of the US demand for oil. Cartoon by Ingram Pinn.



inflation example

If you have £1 and inflation is 5%, after a year the pound will be worth £0.95. Inflation has diminished the value of your money. If you saved £1 in an investment with a 4% return, after a year your investment will be worth £1.01. Inflation has eradicated part of your return. Alternatively, if you owe £1, then after a year that pound would be worth £0.95 - the inflation will have cleared part of your debt.



effects of inflation

Inflation can cause consumers to become more cautious in their spending, which can damage economic output over time. Banks struggle to adjust their rates in order to compensate for inflation and so lend less. Money becomes worth less, meaning those on fixed incomes can afford less and their standard of living declines. Prices have to keep up with the pace of change and home-produced products struggle to compete with imports. As the currency becomes devalued, consumers hold onto tangible assets, creating scarcity. At the extreme, galloping inflation or hyperinflation occurs - currency devaluation can lead to a nation's economic collapse. 

However, a moderate amount of inflation can be the sign of a growing economy. Without it, high unemployment, a liquidity trap and the risk of deflation can result.

The key is balance.

Analysts focus on many different kinds of inflationary pressures and might use the following terms:

inflation expectations

Rate of inflation that workers, businesses and investors think will prevail in the future, and that they will therefore factor into their decision-making.[1]

asset inflation

When the price of land, shares etc rises more quickly than the rate of economic growth.[2]

core inflation

Rate of inflation excluding (generally more volatile) food and energy prices.[3]

cost-push inflation

When the driving force behind rising prices is the increased cost of producing goods, rather than stronger demand by consumers.

creeping inflation

When inflation is rising slowly, but more quickly than people realise[4]

counter inflationary

Measures that are able to or intended to reduce inflation

demand-pull inflation

When the driving force behind rising prices is stronger demand by consumers, rather than the increased cost of producing goods.

deflation

A sustained fall in the prices of goods and services, and thus the opposite of inflation. Not to be confused with disinflation, which is a slowing down of price rises (a fall in the inflation rate). See deflation for more

disinflation

A sustained slowing down in price increases (in the rate of inflation). Not to be confused with deflation, which is a sustained fall in prices.

double-digit inflation

When prices rise at between 10 and 99 per cent per year.[5]

galloping inflation

Very high inflation that is out of control.[6]

negative inflation

This simply describes a situation when the annual inflation rate turns negative, with an accompanying fall in consumer prices.[7] 

wage inflation

Increase in people's pay

wage-push inflation

A situation in which wages rise but workers do not produce any more goods than before, so that goods cost more to make and buy.[8]

Inflation in the news

In January 2013 there were concerns that inflation in China was once again on the rise. The Brazil inflation rate was also prompting concerns among economists that it was stuck in a phase of low growth and high inflation. Meanwhile, gilt yields tumbled after the UK's Office of National Statistics unexpectedly decided not to tamper with the retail price index which is the reference for about £300bn worth of gilts.

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Measuring inflation (not that wonkish, really)