The inflation rate describes how quickly prices are rising for the goods and services you need to survive. The government keeps track of price changes by tracking a basket of goods and services that represent the consumption habits of about 90% of the population. The basket includes commodities like food grains, metals, fuel and utilities such as electricity and transportation. It also includes services like healthcare, entertainment and labor.
While there are several government datasets that track price changes, most central banks rely on the Consumer Price Index (CPI) published monthly by the Bureau of Labor Statistics to calculate the inflation rate. A variant on the CPI, known as the Producer Price Index (PPI), tracks prices at the wholesale or producer level rather than at the retail or consumer level.
Inflation occurs when increased demand for a good or service competes with a decrease in supply. This can happen for a number of reasons. A disease outbreak, for example, may reduce the number of egg-laying hens leading to higher egg prices. Government policies can also trigger inflation. For example, restrictive zoning regulations can limit the availability of housing and drive up rents. State policies encouraging green energy can lead to a greater need for supplies like wind turbines, driving up their prices.
The biggest cost of inflation is a general erosion of purchasing power. This means that each monetary unit can purchase fewer goods and services than it did in the past. It is this loss of purchasing power that makes it difficult for businesses to plan long-term and make investments.