Inflation is a sustained increase in the general level of prices across an economy. It reduces the purchasing power of money over time: when prices rise faster than income, the same amount of money buys fewer goods and services.
How it works
Inflation is measured with price indexes such as CPI and other national measures. Economists distinguish between the price level and the inflation rate: prices can remain high even after the rate of inflation falls.
Inflation can come from strong demand, supply constraints, wages, commodity prices, exchange rates, expectations, or combinations of these forces. Different sources can require different policy responses.
Why it matters
Central banks usually aim to keep inflation low and stable because high or unpredictable inflation makes planning, saving, borrowing, and investment more difficult.
For markets, inflation affects policy-rate expectations, bond yields, company costs, profit margins, and valuation. The key question is often whether inflation is hotter or cooler than expected and whether the trend looks persistent.
A simple market example
If inflation falls from 4% to 3%, prices are generally still rising; they are simply rising more slowly. That can reduce pressure for tighter policy without reversing the earlier increase in the price level.
Common mistakes
Confusing lower inflation with falling prices. Slower inflation is disinflation; a broad decline in prices is deflation.
Treating all inflation as identical. Temporary energy shocks and persistent services inflation can have different implications.
Frequently asked questions
What is disinflation?
Disinflation means inflation is slowing while the general price level is still rising.
What is deflation?
Deflation is a sustained decline in the general price level.
Why can inflation hurt bonds?
Higher inflation can reduce the real value of fixed payments and push investors to demand higher yields.
Educational content only. Definitions describe common market usage and may vary by jurisdiction, instrument, or institution.