What does the inflation rate mean?

Written by
Tamás D.
Fact checked by
Updated
Apr 2024

The inflation rate is an economic indicator that shows how much prices have increased over a given time. It is usually expressed as a percentage, showing the change from a starting period, such as the previous month or year, e.g. "the inflation rate is 4.5%".

THE ESSENCE

  • The inflation rate shows how much prices have increased over a given time
  • It is a percentage figure (e.g. 2%), which is usually compared to the previous year or month  
  • A level of inflation between 2-3% is generally considered healthy
  • The inflation rate can also be negative if prices fall, in which case it is called deflation

What is the current inflation rate?

Let's take a look at the annual inflation rate in some major economies! The inflation rate indicates how much higher prices were compared to one year earlier. 

The data below are listed as of the time of writing (March 2023), but you can check the latest figures for the US, EU and UK in the TradingView chart embedded above.

  • United States: annual inflation in the US for the 12 months ended January 2023 was 6.4%. This was down from 6.5% in the previous month, according to U.S. Labor Department data.
  • Eurozone: the inflation rate in the euro area of the European Union was 8.5% in February 2023, compared to 8.6% one month earlier, according to the report of Eurostat, the European statistics office.
  • United Kingdom: consumer price inflation in the UK was in double digits, at 10.1% in January 2023. This compares to 10.5% annual inflation reported in December 2022, the Office for National Statistics said.
  • Japan: The annual inflation rate in Japan rose to 4.3% in January 2023 from 4.0% in the prior month, the Ministry of Internal Affairs reported

 

The inflation rate is an important economic indicator because it affects the purchasing power of your money and can impact the decisions that individuals, companies and governments make. High inflation rates can make it difficult for people to plan for the future, while low inflation rates can indicate sluggish economic growth.

The inflation rate is usually expressed as a percentage increase in the overall price level, typically measured by an index such as the Consumer Price Index (CPI) or the Producer Price Index (PPI), or a Harmonized Index of Consumer Prices (HICP).

If it is measured to the previous year, it is called annual inflation, also referred to as year-on-year inflation, which you may see shortened as YoY or Y/Y. Prices can also be compared to the previous month, in which case it is called monthly inflation (month-on-month, or MoM, M/M).

What is an example for inflation rate?

The inflation rate is the percentage increase in the price level of certain goods and services from one period to the next.

For instance, let's say that the average cost of a so-called basket of goods in a country was $100 in January 2022, while one year later, in January 2023, the average price of the same basket increased to $105. This means that the inflation rate between January 2022 and 2023 would be:

[(105-100)/100] x 100 = 5%

In this example, the inflation rate would be 5%, which means that the average price level increased by 5% in the given 12-month period. In other words, on average, goods and services became 5% more expensive during this time, it cost this much more to purchase the same basket of goods.

In reality, inflation rates are usually calculated based on a much larger and more diverse and representative basket of goods and services. For an example, you can dig into the details of the current inflation basket of goods in the UK

Can the inflation rate be negative?

Typically, prices rise over time, but they can also fall. 

So yes, it is possible for the inflation rate to be negative, as it would be in this case – this is called deflation.

Deflation is a decrease in the overall price level of goods and services in an economy over time. In other words, deflation is the opposite of inflation. It means that the same amount of money will buy more goods than it did before.

If we go back to same example as above, and assume that the given basket of goods went from costing $100 in January 2022 to $95 January 2023, then the inflation rate would be:

[(95-100)/100] x 100 = -5%

In this example, the inflation rate would be -5%. Another way to say what happened during this period would be that "there was 5% deflation".

Is deflation good or bad?

While some level of deflation may seem to be good, as people can buy more goods with the same amount of money, longer periods of deflation can also harm the economy.

Think about it! If you knew, or expected that prices will be lower tomorrow than they are today, would you buy anything other than what you really need today, such as food? You can see how this would reduce overall consumption and thus economic growth, leading to decreased investments.   

That is why it is generally considered that a low, stable, long-term inflation rate of around 2-3% a year is the healthiest for an economy.

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Tamás Deme
Author of this article
With over two decades of experience as a financial journalist, proofreader, copy editor, and editor, my mission revolves around making financial knowledge accessible to all. I firmly believe in the power of clear and straightforward writing. My past roles include contributing to Interfax news agency and covering M&A deals for EMIS DealWatch.
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