Define inflation. What are the different methods of measuring inflation and what are the effects of inflation.

In economics, inflation refers to a general increase in the prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduction in the purchasing power of money. The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index.[9] As prices do not all increase at the same rate, the consumer price index (CPI) is often used for this purpose. The employment cost index is also used for wages in the United States.

Most economists agree that high levels of inflation as well as hyperinflation—which have severely disruptive effects on the real economy—are caused by persistent excessive growth in the money supply. Views on low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities. Moderate inflation affects economies in both positive and negative ways. The negative effects would include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include reducing unemployment due to nominal wage rigidity, allowing the central bank greater freedom in carrying out monetary policy, encouraging loans and investment instead of money hoarding, and avoiding the inefficiencies associated with deflation.

Today, most economists favour a low and steady rate of inflation. Low (as opposed to zero or negative) inflation reduces the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn and reduces the risk that a liquidity trap prevents monetary policy from stabilizing the economy, while avoiding the costs associated with high inflation. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control monetary policy through the setting of interest rates, by carrying out open market operations and (more rarely) changing commercial bank reserve requirements.

 The different methods of measuring inflation:--

1. The Consumer Price Index (CPI)

Inflation is an increase in the price of goods or services. The CPI, is “sort of the headline measure of inflation in the U.S. economy” said Erica Groshen a visiting scholar at Cornell University and former commissioner of the Bureau of Labor Statistics, the organization that calculates the CPI.

The Bureau of Labor Statistics (BLS) collects prices of goods and services that the average American consumer buys. “We have about 400 people across the country who collect about 80,000 prices per month of pretty much anything that your household may purchase,” said Stephen Reed, an economist currently at the Bureau of Labor Statistics who works on the CPI.

That market basket of goods and services includes a wide range of items such as food, televisions, prescription drugs, rent, gasoline and college tuition.

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