The percentage change in the prices of a basket of products and services over a period of time, calculated by the country’s statistical office. It is important to measure inflation because it allows us to understand how the purchasing power of an economy’s currency is changing. Generally speaking, high or unpredictable inflation reduces the purchasing power of an economy’s money and slows economic growth by causing a misallocation of resources from investment to short-term consumption needs. It also creates inefficiencies in markets by making it difficult to budget or plan for the long-term and encourages companies to focus on profit and loss from the currency’s depreciation rather than investing in their products.
The rate of inflation differs between countries and over time. This is because the economies of different nations are at different stages in their economic cycle at any given point in time, which will affect how much demand there is for goods and services. For example, times of recession tend to see lower inflation as unemployment rises and household spending habits change. Similarly, when economies are growing strongly, inflation usually starts to rise as people spend more money and demand for goods and services increases.
Each country’s statistical office checks the prices of a set of goods and services that represents what a typical household consumes over a year – this basket is known as a CPI (Consumer Price Index). These prices are then compared with the prices of the same items one year earlier to calculate inflation. The weight given to each product in the basket – how much impact it has on the overall inflation measurement – varies from country to country, and is based on consumer consumption surveys conducted by the statistical offices of each nation.