What is Inflation?

What is inflation?

Inflation is the general rise in prices across a broad range of goods and services over a period of time. Measured by economic indexes such as the Consumer Price Index (CPI) or Personal Consumption Expenditures (PCE) index, inflation means that everyday items like groceries or fuel become more expensive, reducing affordability for consumers if wages don't keep pace. For businesses, inflation can increase input costs, which are often passed onto consumers[1][2].

What is an inflation target?

An inflation target is a specific level or range of annual inflation that a central bank or government aims to achieve to promote price stability, sustainable economic growth, and financial stability. Generally speaking, economists and central banks worldwide (such as the US Federal Reserve, European Central Bank, and Reserve Bank of Australia) generally agree on an inflation target rate of around 2% per year[3][4][5], though some do not announce explicit numerical targets.
Source: U.S. Bureau of Economic Analysis[3]
Source: U.S. Bureau of Economic Analysis[3]
A low inflation rate has several benefits:
  • It encourages consumption and investment, as holding cash becomes less attractive over time.
  • It facilitates moderate wage growth along with economic stability.
  • It helps avoid deflation, a situation where prices decline, discouraging spending and corporate investment.

How do Governments and Central Banks Manage Inflation Targets

Governments and central banks manage inflation targets using a combination of monetary and fiscal policies designed to maintain price stability, a critical factor for sustainable economic growth.
Central banks, such as the Federal Reserve or the European Central Bank, focus on monetary tools like adjusting policy interest rates, open market operations, and quantitative easing to influence money supply and demand, thus controlling inflation around their target[6][7].