What Is Inflation?
Inflation is when the prices of most goods and services continue to creep upward. When this happens, your standard of living falls. That's because each dollar buys less, so you have to spend more to get the same goods and services.
If inflation is mild, it can actually spur further economic growth. If prices rise slowly and gradually, it can encourage people to buy now and avoid future price increases. This increases demand, driving further economic growth. In this way, a healthy economy can usually sustain a 2% inflation rate.
What Causes Inflation?
There are three causes of inflation.
The first cause is called demand-pull inflation. This occurs when demand for a good or service rises, but supply stays the same. Buyers become willing to pay more to satisfy their demand. Demand-pull inflation can be accompanied by irrational exuberance.
The second cause is cost-push inflation. It starts when the supply of goods or services is restricted for some reason, while demand stays the same. When the supply of labor is not enough to meet demand, it can create wage inflation. In the past, inflation in prices generally led to wage inflation, so that companies could retain good workers. However, competition from technological alternatives (such as robotics) and lower-income countries means that wages haven't kept up with prices. Higher prices combined with stagnant wages means your standard of living has decreased. It's another reason for income inequality in the U.S.
The third cause is overexpansion of the money supply. That's when a glut of capital in the market chases too few opportunities. It's often a result of expansive fiscal or monetary policy, creating too much liquidity in the form of dollars or credit.
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