Inflation is a measure of the average change in prices for a basket of consumer goods and services over time. Its primary function is to provide a consistent measure of changes in the cost of living, adjusting for differences in purchasing power over time. This makes it a key gauge of economic well-being for households and businesses, and is one of the primary factors that governments seek to control when setting their policies.
During the COVID-19 pandemic, headline inflation surged for very different reasons across countries, from higher energy prices in response to geopolitical tensions to disruptions in the supply chain due to snarled shipping routes and shuttered childcare centers. These volatile shocks drove up the overall price index, while a slowing economy also contributed to lower core inflation. In the longer term, the main driver of headline inflation has been the steady increase in the supply of money and credit.
When the supply of money outpaces economic growth, a country experiences sustained inflation. This happens because when prices rise, the purchasing power of a unit of currency decreases. The loss of purchasing power raises the costs of consuming goods and services, and slows overall economic growth.
When inflation is not controlled, it can create economic uncertainty and reduce the incentive for firms to invest, hire workers, or increase salaries. It can also redistribute real resources between individuals and between groups. For example, high inflation can cause pensions to lose purchasing power relative to the general price level and transfer wealth from those on fixed nominal incomes (such as those receiving fixed-rate pensions) to those with variable incomes.