Price Inflation

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DEFINITION of 'Price Inflation'

Price inflation is an increase in the price of a standardized good/service or a basket of goods/services over a specific period of time (usually one year). Because the nominal amount of money available in an economy tends to grow larger every year relative to the supply of goods available for purchase, this overall demand pull tends to cause some degree of price inflation.

The consumer price index (CPI) is the most common measure of price inflation in the U.S. and is released monthly by the Bureau of Labor and Statistics. 

BREAKING DOWN 'Price Inflation'

Price inflation can also be seen in a slightly different form, where the price of a good is the same year over year, but the amount of the good received gradually decreases. For example, you may notice this in low-cost snack foods such as potato chips and chocolate bars, where the weight of the product gradually decreases, while the price remains the same.

Price inflation is a critical measure for central banks when setting monetary policy. When price inflation is rising at a faster pace than desired, a central bank will likely tighten monetary policy by increasing interest rates. In an ideal world, this would encourage savings through higher returns and slow spending, which would slow price inflation.

On the other hand, should inflation remain subdued over a period of time a central bank will loosen monetary policy by reducing interest rates in the hope it incentivizes borrowing and investing to create price inflation. 

In general, a price inflation rate between 2 and 3 percent in the U.S. is considered desirable.