Inflation is a sustained rise in the general level of prices. One price going up, such as a single holiday fare or a new phone model, is not inflation by itself. Inflation is about the average of many prices drifting higher, so that the same money buys less over time.

How inflation is measured

Statistical agencies build consumer price indices from baskets of goods and services that represent typical spending. In the United States, the Consumer Price Index (CPI) from the Bureau of Labor Statistics is widely cited; the Federal Reserve also watches Personal Consumption Expenditures (PCE) inflation. In the United Kingdom, the Office for National Statistics publishes CPI and CPIH (which includes owner-occupiers’ housing costs). Headline rates include volatile items such as energy and food; “core” measures strip some of those out to reveal underlying momentum.

Indices are imperfect. Baskets lag changing habits, quality improvements are hard to price, and regional costs differ. Still, a consistent index is better than anecdote when comparing years.

Consumer baskets are not the only price index. The GDP deflator prices domestic production. It equals nominal GDP divided by real GDP, times 100. The GDP deflator calculator runs that identity, and it can turn two deflator indexes into the percent change between them.

Why inflation happens

Economists group causes loosely into demand-pull (too much spending chasing limited goods), cost-push (higher input costs passed along), and expectations-driven dynamics (if people expect rising prices, they build that into wages and contracts). Money and credit conditions matter because inflation is ultimately a monetary phenomenon in the medium run: when spending power grows faster than the economy’s ability to supply goods and services, prices tend to rise.

A right shift of aggregate demand is the demand pull case: a higher price level and higher real GDP in the short run. A left shift of short run aggregate supply is the cost push case, and it can produce stagflation. Both are drawn on the aggregate demand and aggregate supply graph.

A classroom quantity theory sketch writes that link as MV equals PY. The velocity of money calculator solves it with numbers you type. Velocity is not constant, so money growth and inflation need not move together in the short run. Which stock you call money also matters. US M1 and M2 are different aggregates, and a definition change can move one of them on its own. See what M1 and M2 include.

Short-run shocks, including oil disruptions, supply-chain breaks, and tax changes, can move measured inflation even when the underlying stance of policy is unchanged. Distinguishing one-off level shifts from ongoing inflation is a central task for the Bank of England and the Federal Reserve.

Targets and policy responses

Both the Bank of England and the US Federal Reserve pursue inflation targets around 2% (the BoE’s target is explicitly 2% CPI; the Fed’s longer-run goal is 2% PCE). When inflation runs hot, tighter monetary policy aims to cool demand through higher policy rates and reduced balance-sheet support. Fiscal policy can reinforce or offset that effort through taxes and spending. A classroom Taylor rule sketch maps those inflation and activity gaps into a suggested policy rate. Try the Taylor rule calculator if you want the arithmetic. A classroom Phillips curve sketch maps an unemployment gap into an inflation gap versus expectations. Try the Phillips curve calculator.

Real vs nominal. A 4% pay rise with 5% inflation is a real pay cut. Always subtract inflation when comparing wages, pensions, or returns over time. Try the inflation adjuster for a simple illustration. To turn a quoted interest rate into a real rate, open the real interest rate calculator.

Who feels inflation

Inflation redistributes. Debtors may gain in real terms if debts are fixed in cash; creditors and cash savers lose purchasing power. Households that spend a larger share of income on essentials feel food and energy spikes more sharply. Indexation (of benefits, pensions, or contracts) softens the blow but can also embed inflation if it feeds a wage and price loop.

UK and US framing

UK inflation discussions often emphasise CPIH and the energy price cap’s role in recent cycles. US discussions often highlight shelter costs in CPI and the Fed’s dual mandate (inflation and employment). Cross-country comparisons should use consistent concepts and note exchange rates when converting values.

Related reading: monetary and fiscal policy, unemployment, and glossary entries for CPI, real interest rate, and purchasing power.

Sources

Go deeper: headline versus core inflation, CPI versus PCE, Phillips curve, Phillips curve calculator, output gap, real interest rates, velocity of money calculator, money supply M1 and M2, GDP deflator calculator, how to read CPI.