What is inflation and how does it fall?
Inflation is the rate at which the prices of goods and services increase over time. It is typically measured as a percentage change in the Consumer Price Index (CPI), which is a basket of goods and services that are commonly purchased by households.
Inflation can be caused by a number of factors, including:
Excess aggregate demand: This occurs when there is more money chasing too few goods and services. This can happen when the economy is growing rapidly or when the government prints too much money.
Cost-push inflation: This occurs when the cost of producing goods and services increases, such as due to higher wages or raw material prices.
Supply shocks: These are unexpected events that reduce the supply of goods and services, such as a natural disaster or a war.
Inflation can have a number of negative consequences for the economy. It can erode the purchasing power of consumers and businesses, and it can lead to uncertainty and instability.
How does inflation fall?
Inflation can fall when the factors that are driving it subside. For example, if excess aggregate demand is the cause of inflation, then inflation may fall if the economy slows down or if the government raises taxes or interest rates. If cost-push inflation is the cause, then inflation may fall if the cost of producing goods and services decreases. And if a supply shock is the cause, then inflation may fall if the supply of goods and services increases.
Central banks play a key role in keeping inflation under control. They do this by using monetary policy tools to influence the supply of money and interest rates. For example, if central banks are concerned about inflation, they may raise interest rates to make it more expensive to borrow money. This can help to reduce aggregate demand and bring inflation down.