What Is Inflation?

Inflation is the rate at which the general level of prices for goods and services rises over time, and therefore the rate at which the purchasing power of money falls. If inflation is 3 percent a year, something that costs 100 today will cost about 103 next year, and your money will buy slightly less.

How it is measured

Statistical agencies calculate inflation using price indexes. The best known is the consumer price index, or CPI, which tracks the cost of a basket of items that households typically buy, such as food, housing, transport, health care and education. The percentage change in the index over a period, usually a year, is the inflation rate. Different countries and agencies use different baskets and methods, and some publish measures that exclude volatile items such as food and energy.

Why it happens

• Demand-pull: demand for goods and services grows faster than supply.
• Cost-push: higher costs for labor, energy or materials raise prices.
• Money supply and expectations: increases in the money supply and expectations of rising prices can feed inflation.
• Supply shocks: disruptions such as wars, pandemics or bad harvests.

Central banks influence inflation mainly by changing interest rates and other tools.

Effects on students

• Costs of living: rent, food and transport can rise, stretching budgets.
• Tuition and fees, which in many places rise faster than general inflation.
• Wages and aid: pay and financial aid may not keep up with prices.
• Savings: cash savings lose value when interest rates are below inflation.
• Loans: fixed-rate debt becomes easier to repay in real terms if incomes rise, though variable rates may increase.
• Planning: future costs, such as a master's degree, should be estimated with inflation in mind.

Real versus nominal

Nominal values are the numbers you see, and real values adjust for inflation. If your savings earn 4 percent and inflation is 3 percent, your real return is about 1 percent.

Protecting yourself

• Budget regularly and track spending.
• Seek higher wages, and plan for pay increases.
• Use interest-bearing accounts and compare rates.
• Invest for the long term if appropriate, understanding risks.
• Avoid high-interest debt.
• Consider inflation-linked options where available.

Deflation

When prices fall, it is called deflation. It can discourage spending and investment, and it brings its own economic problems.

Related terms

See compound interest, minimum wage, isa, tfsa and gross vs net pay.