Inflation is the measure of the increase in the price of goods and services over time(usually a year).
Imagine if your wage doubles but everybody else's wage triples, this will mean you are now poorer than everyone else.
If there is an overall increase in the price of goods and services of 5% this year.
You will need to earn at least 5% more to prevent becoming poor in real terms.
Today each dollar buys you approximately 39 x fewer potatoes than a hundred years ago.
Governments constantly track inflation and try to keep it low through their central banks such as the bank of England.
So why does inflation happen?
This is where raw materials rise in price or employers ask for more money and succeed. This can be due to a shortage of good workers which gives current staff more leverage. The cost of factories or goods needed to make the end product might be increasing as well. These prices increases are then pushed on to the consumer.
This is when there are people who want something and there is not enough supply of it. This is usually caused by a reduction in tax as people get richer and have more money to spend.
A fall in interest rates:
will also increase consumer spending as people have more money to spend and spending is cheaper. When this demand increases suppliers will raise their prices to match it.
The final cause of inflation is Government printing money.
This process is know as quantitative easing. The Government uses this money to loan to banks and thereby making it easier for us to get loans. The government can also use the money to invest in companies by loaning them money. This means businesses can invest more money into the economy(through hiring new employees, innovation etc) and increase wealth.
Inflation does not happen immediately, It takes time before inflation occurs after the causes of inflation have already been put into motion.
Inflation Isn't necessarily bad as long as income is rising at the same rate.
why is inflation a problem?
Inflation is a problem because it affects the returns on your savings and investments. If your savings and investments are not outperforming inflation this means you are losing money.
Inflation is also an issue because not everything increases at the same rate, some goods might experience price inflation months if not years earlier than others.
Low inflation vs High inflation
Low Inflation causes prices to go up, unemployment to rise and encourages investing(as people see value in a devalued currency) whilst reducing the cost of borrowing.
High inflation causes interest rates to rise as the government tries to discourage people from spending. It reduces spending as people don't make enough to afford the rising prices.
High inflation also increases unemployment as people spend less and business make less forcing them to cut staff and further encourage the cycle.
Inflation is worse for low income households and those with fixed-income investments(such as loans) as the value of their money is decreasing and not increasing faster than inflation.
Inflation is measured by the consumer price index. This is a basket of goods used to determine the percentage rate of inflation.