The inflation rate is the percentage increase in the prices of a basket of goods and services that consumers purchase in an economy over time. This measure is used to track economic trends and influences consumer and business decisions. A low and stable inflation rate is often viewed as a sign of a healthy economy while high or rapidly rising inflation can be seen as a problem. Inflation reduces the purchasing power of a currency and can cause real and perceived problems for individuals, businesses and the financial system as a whole.
There are many ways that inflation can occur and its causes vary. It can be the result of a rise in demand that exceeds production capacity (demand-pull inflation), or it can be a result of overprinting of money that distorts the value of currency and leads to higher prices and an eroded purchasing power (print-push inflation). Inflation is also caused by events that restrict production capacities, such as natural disasters or wars, which can lead to supply-side shocks that push prices up.
Because some of the underlying causes of inflation are volatile and can change quickly, most governments and markets monitor inflation by focusing on core price indices that exclude the prices of food, energy and oil. These indices are less sensitive to short term supply and demand fluctuations in these markets and better reflect long run trends in prices.
For example, since energy costs make up a significant portion of most household budgets, changes in oil and gasoline prices tend to have a strong influence on the overall CPI. Additionally, recipients of Social Security and other transfer payments receive annual cost of living adjustments based on the Consumer Price Index for Urban Wage Earners and Clerical Workers, which removes volatile food and energy items.