What is inflation and how is it measured?
Short answer
Inflation is a sustained rise in the general price level of goods and services. It is usually measured with a consumer price index (CPI), which tracks the price of a fixed basket over time.
Checklist
- Remember the definitionA sustained rise in the general price level.
- Tell the indicators apartCPI, PPI and core inflation measure different things.
- Check the type of rateVerify whether it is monthly or annual.
- Use official sourcesRefer to the statistics agency's releases for current figures.
Inflation is a sustained increase in the general level of prices of goods and services in an economy. A price rise in a single product is not inflation; it refers to a broad and lasting increase in prices. As inflation rises, the same amount of money buys fewer goods and services, meaning the purchasing power of money falls.
How is inflation measured?
The basic method is to build a price index. A “basket” of goods and services that households regularly buy is defined, its price is tracked in each period and compared with a base period. If the cost of the basket has risen, there is inflation.
- Define the basketRepresentative goods and services are chosen from spending groups such as food, clothing, housing, transport, health and education.
- Assign weightsBased on household budget surveys, each group is given a share of total spending; items people spend more on have a larger effect.
- Collect pricesPrice data are gathered regularly from different places and points of sale.
- Calculate the indexThe current cost of the basket is divided by its cost in the base period to obtain the index value.
- Find the rate of changeThe change in the index versus the previous month or the same month of the previous year is expressed as a percentage.
Main indicators
- Consumer Price Index (CPI): Shows price changes of goods and services bought by households; it is the most widely used inflation measure.
- Producer Price Index (PPI): Tracks price changes of goods sold by producers; it often hints at cost pressures that may pass through to consumer prices.
- Core inflation: Derived measures that exclude volatile items such as food and energy to show the steadier underlying trend.
What causes inflation?
- Rising demand: If total spending grows faster than productive capacity, prices go up.
- Cost pressure: Higher energy, raw material, wage or exchange-rate costs are passed on to prices.
- Money supply and expectations: An excessive increase in the money supply and expectations that prices will keep rising can reinforce the process.
Frequently asked questions
If inflation falls, do prices fall too?
No. Lower inflation means prices are rising more slowly. A fall in the general price level is called deflation.
Is inflation the same for everyone?
No. The index is based on an average basket; households with different spending patterns may experience price increases that differ from the official rate.
Is inflation always bad?
Low and stable inflation is considered acceptable in many economies. High and unpredictable inflation makes planning harder and erodes purchasing power.
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