Inflation
A sustained rise in the general price level: how it is measured, what causes it, and why central banks target low stable rates.
Inflation is a sustained increase in the general price level of an economy, usually measured over a year. It is distinct from a relative price change: if the price of oil rises while other prices fall, the average price level may be unchanged. Inflation describes the average, which is why it is measured with price indices — baskets of goods weighted by spending. The most familiar is the Consumer Price Index (CPI), which tracks a representative basket of household purchases; alternatives include the Producer Price Index and the GDP deflator.
Measuring the price level raises well-understood problems. Baskets become outdated as products and spending patterns change; substitution — consumers buying cheaper alternatives when a price rises — biases fixed-basket indices upward; quality improvements make a higher price partly a payment for a better good. Statistical agencies address these with periodic basket updates, hedonic quality adjustments, and alternative indices, but no index is perfect, and measured inflation always involves judgment.
Economists distinguish several causes, which can operate together. Demand-pull inflation occurs when aggregate demand grows faster than the economy's capacity to produce, bidding prices up. Cost-push inflation comes from rising input costs — the oil shocks of the 1970s are the canonical example. Monetary explanations emphasize that sustained inflation requires sustained growth of the money supply beyond real output; the quantity equation MV = PY expresses the link, and Milton Friedman's claim that inflation is "always and everywhere a monetary phenomenon" summarizes this tradition — a widely influential but debated position. Expectations matter too: if workers and firms expect inflation, wage and price setting builds it in, creating self-fulfilling dynamics.
Inflation has real costs. Menu costs are the literal expense of changing prices; shoe-leather costs describe the effort of economizing on cash when cash loses value; tax systems interact badly with inflation; and unanticipated inflation redistributes wealth between creditors and debtors, since loans are repaid in less valuable money. Mild, anticipated inflation is usually considered a minor nuisance, but high and volatile inflation damages planning and trust, and hyperinflation — inflation of thousands of percent per month, as in Weimar Germany, Zimbabwe, or modern Venezuela — destroys the monetary system's function entirely. Deflation, the opposite, is also feared: falling prices encourage waiting, raise the real burden of debt, and can produce a deflationary spiral.
Because of these costs, most central banks target low, stable inflation, commonly around 2 percent per year. Monetary policy — primarily interest rates — leans against demand-pull pressures, and credibility of the target helps anchor expectations. The modern consensus that moderate inflation is preferable to zero or negative inflation reflects the evidence that small positive inflation greases relative price adjustments and reduces the risk of deflation, though the optimal target remains an active research question.
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economics inflation monetary policy prices