Inflation explained: why prices rise and how central banks respond
Inflation is the rate at which the general level of prices rises. A little is considered healthy: many central banks, including the US Federal Reserve, the European Central Bank and the Bank of England, target around 2 percent a year. Too much erodes savings and wages; too little can signal a weak economy.
What pushes prices up
- Demand-pull: people and businesses want to buy more than the economy can produce.
- Cost-push: energy, food or shipping costs jump, and companies pass them on.
- Expectations: if everyone expects higher prices, workers ask for bigger raises and firms raise prices in advance.
The central bank’s main tool
When inflation runs too hot, central banks raise their policy interest rate. Borrowing becomes more expensive, saving more attractive, and spending slows — eventually easing pressure on prices. It works with a delay, often a year or more, which is why policymakers watch forecasts closely.
What it means for you
Higher rates raise mortgage and loan costs but improve returns on savings. Over the long run, the best protection against inflation for most households is income that keeps pace and savings invested in assets that can grow faster than prices.
Inflation is a tax nobody votes for. Central banks exist largely to keep it small and predictable.