Inflation is the rise in the general price level of goods and services over time. As prices increase, the value of money decreases. A $10 note buys less today than it did five years ago. This change affects everything from groceries to mortgages to long-term financial plans.
In this guide, you’ll learn what inflation is, how it’s measured, why it happens, how it affects the economy, and what history has taught us about managing it.
Understanding Inflation
Inflation is the rate at which the cost of goods and services increases across the economy over a set period. It reflects how much more you need to spend to maintain the same standard of living.
Consumer Price Index (CPI)
The CPI tracks the cost of a typical shopping basket. This includes everyday items like bread, rent, electricity, and travel. A 5 percent rise in the CPI over one year means that, on average, prices have increased by 5 percent.
Producer Price Index (PPI)
The PPI measures price changes from the business side. If transport costs or raw materials rise, manufacturers often pass these costs on to consumers later. PPI trends can help predict changes in CPI.
Historical Example: In 1975, the UK’s inflation rate peaked at over 25 percent. A mix of global oil shocks and domestic wage demands pushed prices to record highs, triggering a long period of economic uncertainty.
How Inflation Is Measured
Inflation is usually expressed as a percentage. The standard formula is:
(New Price – Old Price) / Old Price) × 100
For example, if a cinema ticket cost £6 last year and now costs £7.20, the inflation rate for that ticket is 20 percent.
Monthly updates from the Office for National Statistics help policymakers and economists track these changes and make decisions accordingly.
Causes of Inflation
There is no single cause of inflation. Below are the most common triggers, each with real-world historical context.
Demand Pull Inflation
Prices rise when demand for goods and services outpaces supply.
Example: After the COVID-19 lockdowns, pent-up demand and government stimulus payments in the US and UK caused a spike in consumer spending. Car prices soared due to a shortage of semiconductors, and retailers struggled to keep up with orders.
Cost Push Inflation
This occurs when the cost of production rises, and businesses increase prices to protect profit margins.
Example: In 1973, the OPEC oil embargo caused global oil prices to quadruple. Transport, manufacturing, and energy costs all spiked, feeding into broader price increases across the board.
Built In Inflation
Also called the wage price spiral, this happens when rising prices lead workers to demand higher wages, which in turn drives prices up further.
Example: In 1970s Britain, frequent union strikes for wage increases contributed to a cycle of rising wages and prices. This prolonged inflation and weakened economic growth.
Excess Money Supply
When central banks introduce too much money into the economy without equivalent growth in production, inflation rises rapidly.
Example: Germany’s Weimar Republic in 1923 printed large volumes of money to cover war debts. A loaf of bread that cost 250 marks in January jumped to over 200 billion marks by November. Hyperinflation erased savings and collapsed the economy.
Types of Inflation
Economists use different terms to describe the pace and scale of inflation.
Creeping Inflation
A small, steady increase in prices, typically between 1 and 3 percent per year. This level is usually seen as healthy and manageable.
Walking Inflation
Moderate inflation, ranging from 3 to 10 percent. It can lead to reduced purchasing power and may prompt policy intervention.
Galloping Inflation
Fast and high inflation, often over 10 percent. It signals an overheated economy and can cause long-term damage.
Hyperinflation
An extreme and rapid price rise, usually over 50 percent per month.
Example: In Zimbabwe in the late 2000s, hyperinflation reached astronomical levels. At one point, a loaf of bread cost over 1 trillion Zimbabwean dollars. The government eventually abandoned the currency and adopted the US dollar.
Ongoing Example: Argentina has faced persistent inflation for over a decade. In 2023, inflation exceeded 100 percent, making everyday budgeting difficult and hurting consumer confidence.
Effects of Inflation
Positive Effects
- Boosts spending
When prices are expected to rise, people are more likely to buy now, which can stimulate the economy. - Reduces debt burden
Loans with fixed repayments become cheaper in real terms if inflation and wages rise.
Negative Effects
- Reduces purchasing power
Households need more money to buy the same goods, which can squeeze lower-income families. - Hurts savers
If inflation outpaces interest earned on savings, the real value of savings declines. - Increases uncertainty
Businesses may delay investment or hiring if they can’t predict future costs or revenues.
How Inflation Is Managed
Governments and central banks use a combination of policies to control inflation and maintain stability.
Monetary Policy
Central banks like the Bank of England adjust interest rates to influence borrowing and spending. Raising interest rates slows demand, helping to cool inflation.
Example: In the early 1980s, the US Federal Reserve raised interest rates to nearly 20 percent to curb inflation. This caused a recession, but it successfully brought inflation down from double digits.
Fiscal Policy
Governments can raise taxes or cut public spending to reduce excess demand and help control price growth.
Personal Strategies
- Invest in inflation-resistant assets
Property, commodities, and inflation-linked bonds tend to hold their value during inflationary periods. - Diversify income
Having more than one source of income can help maintain stability when prices rise. - Adjust savings and spending
Reviewing budgets and choosing higher-yield savings options can reduce the impact of inflation on long-term plans.
Inflation affects every part of the economy. A low, stable rate supports growth, but too much inflation reduces the value of money, damages trust in financial systems, and increases inequality.
History shows that inflation must be taken seriously. From postwar Britain to modern-day Argentina, the lesson is clear. Tracking inflation, understanding its drivers, and responding early is essential for individuals, businesses, and governments alike.
