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What is inflation?

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Quick answer

Inflation is the rate at which the general level of prices rises over time, which means each unit of money buys a little less than before. Moderate inflation is normal in a growing economy; very high inflation erodes savings quickly.

Key things to understand

  1. It's usually measured by a price index like the Consumer Price Index (CPI), which tracks a basket of everyday goods.
  2. Demand-pull inflation happens when demand outpaces supply; cost-push inflation comes from rising production costs.
  3. Central banks often target around 2% inflation and raise interest rates to cool it when it climbs too high.
  4. Inflation reduces the purchasing power of cash, which is why long-term savings are often invested.

People also ask

Why do central banks want some inflation?
A small, steady rise in prices encourages spending and investment and gives a buffer against deflation, which can be more damaging.
How does inflation affect my savings?
If your money earns less than the inflation rate, its real purchasing power shrinks over time even though the number stays the same.
What causes high inflation?
Rapid money-supply growth, supply shocks (like an oil-price spike), or demand far exceeding what the economy can produce.