Inflation is the general rise of prices for goods and services across a country’s economy (deflation is the general decline in such prices). High inflation can have negative effects on the economy, which are typically avoided with careful economic management.
The government agencies that track price movements in an economy usually measure inflation by comparing the prices of a basket of goods and services over time. These baskets are called indices. One widely used index is the Consumer Price Index, which is calculated by the Bureau of Labor Statistics. It is a popular way for consumers, business leaders and policymakers to track overall price changes.
Several factors can influence inflation rates, including demand-pull and cost-push inflation. When demand for goods and services exceeds the economy’s ability to produce them, prices rise. This is known as demand-pull inflation and can be caused by big government spending, monetary expansion or wars. A shortage of key raw materials or supply disruptions can also raise prices and is called cost-push inflation.
In both cases, prices rise faster than wages. This leads to rising income inequality and erodes the purchasing power of currency. Unevenly rising prices can compel people to hoard commodities or other items as stores of value. This can lead to shortages in some areas and create political instability.
Inflation can affect many facets of the economy, from a person’s spending power to the interest rate on the national debt. Understanding inflation is important for investors because it can affect their savings and investments. If you have questions about how inflation may affect your financial plans, a SmartAsset advisor can help. Use our free tool to connect with vetted financial advisors in your area who can help you build an investment plan that is protected from inflation and other market volatility.