The rate of inflation is a measure of how fast prices are rising in an economy on average. This is a key economic indicator and it can have both positive and negative effects. Moderate inflation is a sign of a healthy economy but high rates can have serious consequences including making it harder for consumers and businesses to make decisions, leading to uncertainty and losing the purchasing power of currency. It can also create shortages of goods as consumers hoard them for fear that prices will rise further in the future.
Inflation rates are calculated by comparing prices of a ‘basket’ of goods and services that are typical of household consumption in an economy, such as bread, petrol, clothing and leisure activities. This basket is determined by statistical offices and similar institutions using detailed consumption surveys. The baskets are updated regularly to reflect changes in consumer spending habits.
Generally speaking, inflation is a result of an imbalance between supply and demand for goods and services. Supply refers to the ability of companies to produce and sell their goods and services while demand includes things like consumer spending, interest rates and expectations. When the increase in demand outpaces the increases in available supplies or when the price of essential raw materials and fuels rise, this can lead to higher inflation.
However, not all types of inflation are the same and different types of inflation can have different causes. This is why most countries and international organizations track both headline and core inflation. The core inflation rate is a more accurate measure of long run price trends as it excludes volatile components like food and oil prices that can be affected by short term supply and demand conditions in specific markets.