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Inflation Basics: What Makes Prices Rise

Here's what inflation is, why it happens, and how central banks try to keep it in check.

  1. What is inflation?

    Inflation is a sustained rise in the general price level of goods and services in an economy, meaning the same amount of money buys less over time; in other words, the real purchasing power of currency falls. A sustained fall in prices is called deflation.

  2. The main causes of inflation

    Demand-pull inflation happens when a strong economy pushes consumer and investment demand beyond what supply can meet, while cost-push inflation happens when rising costs, like raw materials or wages, lead businesses to raise prices. An oversupply of money circulating in the economy can also devalue currency and add to inflationary pressure.

  3. Historical examples of hyperinflation

    In 1920s Weimar Germany, printing huge amounts of money to cover World War I reparations led to hyperinflation so severe that prices could rise dozens of times over in a single month. In the late 2000s, Zimbabwe experienced a similarly extreme bout of hyperinflation caused by excessive money printing, eventually abandoning its own currency in favor of the US dollar and other foreign currencies.

  4. How central banks use interest rates to manage inflation

    When prices are rising too fast, central banks raise their benchmark interest rate, making borrowing, spending, and investing more expensive, which slows the flow of money through the economy and eases inflationary pressure. When the economy is weak and inflationary pressure is low, they lower rates instead to encourage spending and investment.

  5. How inflation is measured

    National statistical agencies track inflation using a Consumer Price Index (CPI), a weighted average of price changes across everyday items like groceries, housing, and transportation. In the US, the Bureau of Labor Statistics publishes the CPI monthly, and it's a key input into monetary policy decisions.

  6. Inflation and personal finances

    When inflation persists, the real value of cash or low-interest savings can erode over time, which is why many people look toward assets that might outpace inflation. This page provides general educational information about an economic phenomenon and is not investment advice; please research thoroughly or consult a professional before making any specific investment or asset allocation decisions.

Why do prices keep going up?

Inflation is an economic term that shows up in the news every month, but understanding its causes and how central banks respond makes it much clearer how changing prices connect to everyday life. This page offers general educational information about the concept and mechanics of inflation and is not investment advice; please research thoroughly or consult a professional before making any actual investment or asset management decisions.

Why deflation isn't simply the opposite of good

While runaway inflation clearly hurts consumers, sustained deflation, falling prices, brings its own problems: businesses postpone spending in anticipation of even lower prices, consumers delay purchases for the same reason, and the resulting drop in demand can slow economic growth and raise unemployment. That's why most central banks target low, stable, positive inflation rather than trying to eliminate price increases altogether.

Frequently Asked Questions

Is inflation always a bad thing?

A mild, steady level of inflation is generally seen as a natural byproduct of economic growth, but when prices rise too quickly, purchasing power can fall sharply and put a strain on the broader economy.

Why do central banks raise interest rates to fight inflation?

Raising interest rates makes borrowing, spending, and investing more expensive, which reduces the amount of money circulating in the economy, and that reduced demand helps ease upward pressure on prices.