What is inflation?

The International Monetary Fund defines inflation as “the rate of increase in prices over a given period of time,” which is typically a year. It measures how much more expensive a set of goods and services becomes, which is reflected as an annual percentage rate.

Inflation may be used as a broad measure, such as reflecting the overall increase in consumer prices or the uptick in a country’s cost of living. However, it can also be calculated narrowly, such as for certain goods, foods, or services.

Ultimately, inflation erodes the purchasing power of a currency. Over the long term, people can afford fewer goods and services for the same amount, which typically decreases consumer spending in certain uncritical areas.

Moderate inflation is considered normal in a healthy economy as it can encourage spending and investment. However, hyperinflation or deflationary pressures alike can take a toll on the economy.

Central banks, such as the Federal Reserve, aim to manage inflation within a target range by adjusting interest rates and implementing monetary policies to achieve price stability. According to the Federal Open Market Committee, “inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Federal Reserve’s mandate for maximum employment and price stability.”

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