An inflation rate measures the rise in prices of goods and services. It is a measure of how fast prices grow over time and is the primary factor that policymakers look at in setting interest rates to encourage economic growth and to discourage unsustainable price increases (a phenomenon called deflation).
Inflation affects everyone, but it has different effects on people with different income levels. Low or moderate inflation is considered good for the economy, because it increases demand and helps businesses sell more stuff. This stimulates hiring and wages, which in turn boosts spending — a virtuous cycle.
But, if the inflation is too high it distorts purchasing power and can make it harder for families to meet their needs and wants. People on fixed-incomes can be disproportionately affected by inflation. For example, someone on a 3 percent yearly increase to their pension would see the real value of that money decline in an inflationary environment. People who are on contract-based salaries may be at risk of layoffs as companies cut costs to match rising prices.
Inflation is caused by many factors, from a limited supply of fuel to an overly relaxed monetary policy. Some prices change every day, while others take longer to adjust (known as sticky pricing in economics terms). The fastest-changing prices are those for goods and services that are consumed directly by end consumers. Inflation can also distort the value of inputs, such as raw materials. This is known as cost-push inflation.