Inflation
A sustained rise in the general level of prices, so each unit of money buys less over time.
In plain words
Inflation is what happens when the same basket of goods — bread, rent, electricity — costs more this year than last. Central banks measure it with a consumer price index (CPI): a weighted average of hundreds of prices, updated every month.
A little inflation (around 2%) is normal and even useful. It gives businesses room to adjust relative prices without anyone having to take a pay cut in absolute terms. Very high inflation erodes savings and makes long-term planning hard.
Think of it this way: if £100 fills your shopping trolley today, the same £100 after a year of 5% inflation only fills 95% of it. After ten years at 5%, it buys just 61% of what it once did.
Prices rose fast, then slowed — but didn't fall.
What causes inflation?
Economists identify three main drivers, which often overlap in practice.
Demand-pull
Too much money chasing too few goods. When consumers and governments spend heavily, businesses raise prices to ration supply.
e.g. Post-pandemic stimulus spending, 2020–21Cost-push
Rising production costs — energy, wages, raw materials — force businesses to charge more even when demand hasn't changed.
e.g. 1973 OPEC oil embargo, energy crisis 2022Built-in
Workers expect prices to rise, so they demand higher wages. Businesses pass those costs on. Expectations become self-fulfilling.
e.g. 1970s wage-price spiral in the UKHow it's measured
Price collectors visit thousands of shops, websites, and service providers each month — recording the cost of a fixed basket of hundreds of goods and services.
Each category is given a weight matching its share of typical household spending. Housing costs more and weighs more; tobacco weighs little. The result is a single index number.
Divide this month's index by the same month last year, subtract 1. That gives the 12-month inflation rate — the number you see in headlines every month.
π(t) = I(t) ÷ I(t − 12) − 1 12-month inflation rate from the price index I π > 0 Inflation: prices rising π = 0 Price stability: no change on average π < 0 Deflation: prices falling Why it matters
At 5% inflation, £100 today has the buying power of just £61 in 10 years — even if the number on your bank statement hasn't changed.
A 4% pay rise when inflation is 6% means a 2% real pay cut. The number on the payslip grew; your purchasing power didn't.
Central banks target around 2% inflation — enough to keep the economy active, not so much that it erodes trust in money. Their main tool is the policy interest rate.
Common misreadings
"Inflation is falling, so prices are going down."
Falling inflation means prices are rising more slowly, not reversing. For prices to fall, you'd need deflation — a negative rate.
"Inflation only affects the poor."
Inflation affects everyone with cash savings, fixed incomes, or long-term contracts. Lower earners feel it more acutely because they spend more of their income on necessities like food and energy.
"The government controls inflation."
In most countries, inflation is managed by an independent central bank, not the elected government. Fiscal policy (tax and spending) can influence inflation, but monetary policy is the primary lever.
Frequently asked questions
What is inflation in simple terms?
Inflation means prices across the economy are rising on average, so each pound or dollar buys less than it did before. It is measured by tracking the cost of a fixed basket of goods and services over time.
What causes inflation?
Inflation can be caused by excess demand (too much money chasing too few goods), rising production costs (cost-push), or expectations that prices will rise. Central banks manage it mainly through interest rates.
Is some inflation good?
Most central banks target 2% inflation as a healthy level. A small positive rate gives businesses room to adjust prices and wages without anyone needing a nominal pay cut, and it keeps the economy away from dangerous deflation.
How does inflation affect savings?
If your savings account pays less interest than the inflation rate, the real value of your money falls every year. A 5% inflation rate with a 2% savings rate means you lose roughly 3% of purchasing power annually.