Inflation is defined as a sustained increase in the general level of prices for goods and services in a county, and is measured as an annual percentage change.
- Under conditions of inflation, the prices of things rise over time. Put differently, as inflation rises, every dollar you own buys a smaller percentage of a good or service. When prices rise, and alternatively when the value of money falls you have inflation.
- The value of a dollar (or any unit of money) is expressed in terms of its purchasing power, which is the amount of real, tangible goods or actual services that money can buy at a moment in time. When inflation goes up, there is a decline in the purchasing power of money.
- For example, if the inflation rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in a year. After inflation, your dollar does not go as far as it did in the past. This why a pack of gum cost just $0.05 in the 1940’s – the price has risen, or from a different perspective, the value of the dollar has declined.
- In recent years, most developed countries have attempted to sustain an inflation rate of 2-3% by using monetary policy tools put to use by central banks. This general form of monetary policy is known as inflation targeting.