Over time, inflation raises the cost of goods and services by eroding each currency’s
buying power. It raises one’s standard of living expenses. Inflation in the United States has
eroded the buying power of the dollar. As a result of rising costs, people’s purchasing power
diminishes over time, lowering their quality of life. Inflation is the rise or fall in prices, expressed
as a percentage, over a certain period, generally a month or a year. Price increases over that
period were measured using this percentage. The inflation rate which is a component of the
misery index is an economic statistic that helps to measure a person’s financial well-being and
is crucial. The unemployment rate is also a factor. When the misery index is over 7%, people
are either in the midst of a recession or are fighting inflation (Castillo-Martinez, 2019).
Inflation is caused by one of two things. Inflation that is driven by consumer demand is
by far the most prevalent kind. In this case, the demand for a product or service is greater than
the supply. Customers are prepared to pay more for the goods since they need them so badly.
The prices of various goods increase when there is an increase in demand. The supply of
various products decreases when the demand increases. The second, less typical reason for
inflation is an increase in the price of goods and services (Bohl, 2018). It is at this point that
supply becomes constrained while demand remains unhindered. This occurred as a result of
damage to gas supply lines caused by Hurricane Katrina in 2005. The need for gasoline did not
alter, but the lack of supplies resulted in a $5 per gallon price increase. When there is a
shortage in the supply of various goods, the pressure on prices increases. Prices of various
commodities are likely to increase because people chase few goods using a lot of money.
Higher prices are the result of demand surpassing supply. For example, the prices of products
such as oil have increased in various parts of the world due to limited supply. Supply shocks
disrupting production can lead to decreases in supply. Examples of supply shocks are natural
disasters (Taylor, 2019). When there is a disruption in production, the number of goods that can
be supplied to the customers decreases. This leads to increases in prices creating inflation.
Built-in inflation may also be cited as a third factor. People’s anticipation of future inflation
has a role in this calculation. Increases in salaries are expected by workers, but also boost the
cost of producing a product. Prices for products and services are going up again. When these
causes and effects persist, it forms a wage-price spiral. An increase in production costs can
raise the living costs. As the living cost increases, workers might start to demand higher wages.
Various factors influence each other and they create a cycle. Increases in production costs such
as wages and raw materials lead to cost-push inflation. High production costs lead to a
decrease in the supply of goods. The increased production costs are passed to the consumers,
and they are forced to pay higher prices for various consumer products. The prices of raw
materials such as copper might increase. All companies that use copper as a raw material
would have to increase their prices because of the increased cost of raw materials.
The Consumer Price Index (CPI) is used by the U.S. Bureau of Labor Statistics (BLS)
to calculate inflation (Taylor, 2019). A poll of 23,000 firms is used to compile the index’s data. An
80,000-item pricing database is updated every month. The Consumer Price Index (CPI) will give
you the overall inflation rate. Inflation is also tracked by the Personal Consumption Expenditures
Price Index. In comparison to the CPI, this index covers a broader range of commercial products
and services. The consumer price index determines the price changes of various products and
One can calculate the consumer price index by averaging the price changes of various items in
the basket of goods. The consumer price index can be used to determine the purchasing power
of a particular currency. It does not include the investments and savings of individuals. The
consumer price index is based on an index average that was set to 100. The increases in
average prices are represented as percentage changes in the index based on the index
average from a prior period.
Monetary policy is used by central banks all over the globe to keep inflation and deflation
at bay. Currently, the Federal Reserve in the United States sets a target inflation rate of 2%
each year. By allowing a goal inflation rate of greater than 2%, the FOMC said on August 27,
2020, that it will aid in maintaining maximum employment (Siami-Namini, 2019). The target of
2% inflation remains, but the October 2021 rate shows that it is ready to accept higher rates if
inflation has remained low for a long period. The Fed uses the core inflation rate, which
excludes energy and food costs, to measure inflation. Commodity merchants determine these
prices, which are too volatile to take into account. Monetary policy refers to the communications
and actions of the central bank to manage the money supply. Central banks can use monetary
policy to reduce liquidity. They can use tools such as bank reserve requirements, government
bonds, and interest rates. Central banks can restrict the amount of money that banks can lend.
When there is inflation, the central banks often take action to reduce the money supply. Central
banks can increase interest rates when there are significant increases in prices. They can also
lower interest rates when inflation falls.
Inflation targeting is a strategy used by central banks to maintain price stability. The
federal reserve can use open market operations to control the prices of various commodities.
Open market operations are a tool that central banks can use for monetary policy. The federal
reserve can sell or purchase securities in the market. To increase the money supply, the federal
reserve purchases securities. It sells them to reduce interest rates. Open market operations can
be used to control inflation. They can affect interest rates that also determine the inflation rate.
Bohl, M. T., & Siklos, P. L. (2018). The anatomy of inflation: An economic history perspective.
Prepared for the Handbook of the History of Money and Currency (Vienna: Springer), edited by
S. Battilosi, Y. Cassis, and K. Yago, Forthcoming, CAMA Working Paper, (8).
Castillo-Martinez, L., & Reis, R. (2019). How do central banks control inflation? A guide for the
perplexed. LSE manuscript.
McLeay, M., & Tenreyro, S. (2020). Optimal inflation and the identification of the Phillips curve.
NBER Macroeconomics Annual, 34(1), 199-255.