The basicsInflation is a measure of how fast the prices of goods and services are rising.
What changes inflation: two theoriesDifferent theories try to answer why prices rise at different speeds over time, but there are two central explanations within economics. Consider the analogy of an auction room. If it is full of willing buyers with plenty of money then it is more likely that higher prices can be achieved for a particular lot being sold. In this case the amount of money available, known as the “money supply”, will influence the likely level of prices. If there was less money available then the bidding could not go as high. This is the view of the monetarists who believe that inflation can be controlled by changing the level of money that circulates in the economy, for instance overcoming low inflation by adding more money via programmes such as quantitative easing (QE). Another view is held by Keynesian economists, who treasure the beliefs of the British economist John Maynard Keynes. They believe that demand is the central reason for a change in prices. Revisiting our auction room again, if all the buyers believed that a particular item was in very short supply then they would be willing to pay a higher price for fear of not being able to buy another. In the Keynesian view, this would mean that demand was higher for an item than the supply of that item, hence the price rises until there is a winner.
World inflation since 1970Western economies such as the UK and US have experienced similar levels of inflation in the last few decades. In the 1970s and 1980s, higher levels of inflation were blamed, in part, on the widespread unionisation of workers. Labour market reforms along with a more flexible work force slowed price increases. Other factors, such as demographics and the ageing of populations, may also have played a part.
In more recent years lower commodity and labour prices along with strong domestic currency values have kept inflation to record lows, which have been welcomed by Western households, as their cost of living remains lower.