When you go to the store, you probably notice that prices seem to be rising. This is normal inflation, and it’s usually a good thing. Inflation makes it easier to buy the things you need, while also reducing the real value of your money over time. Inflation can have negative effects if the inflation rate is too high, however.
Inflation rates vary by country or region because some prices are set and regulated, such as the cost of public transport in a particular county. Other prices, such as wages established by contract, take longer to adjust (and are therefore called “sticky”). Differences in inflation rates can even arise when a country is at different stages of the business cycle – with demand for goods and services falling during an economic downturn and rising during an economic boom.
A central bank’s monetary policies can also influence inflation rates. By adjusting interest rates, they can slow the economy and reduce inflation. In the short run, however, high or unpredictable inflation can cause problems as companies may be unable to budget for the long term and workers struggle with the erosion of their purchasing power.
Inflation can also erode people’s confidence in the currency they use. For this reason, the U.S. government offers Treasury Inflation-Protected Securities to help people preserve the purchasing power of their savings. The main cause of inflation, though, is an excess of supply versus the public’s demand for money. As prices rise, the purchasing power of money declines, prompting businesses to increase their costs and workers to demand higher wages. The effect can be self-reinforcing, and is known as built-in inflation.