What causes inflation?

Inflation is a sustained rise in the general price level, measured by indexes such as the Consumer Price Index that track a basket of goods and services over time. The classic framing separates demand-pull inflation, where spending outruns the economy's capacity to produce, from cost-push inflation, where input costs such as energy, labor, or supply chain disruptions push prices up independent of demand. Both were visible in the 2021 to 2023 episode, which combined pandemic stimulus and pent-up demand with shipping bottlenecks and energy shocks, and economists still argue about the relative shares.

Money supply matters over long periods, which is the monetarist insight that inflation is always and everywhere a monetary phenomenon, though the short-run relationship is loose enough that central banks abandoned money-supply targeting decades ago in favor of interest rates. Expectations are the third driver and the one central banks watch most closely: if workers and businesses expect prices to rise, they demand raises and set prices accordingly, and the expectation becomes self-fulfilling. That is why the Federal Reserve talks about anchoring expectations and why it raises rates aggressively when inflation threatens to become embedded.

A few clarifications that matter for reading the news. Inflation is a rate, so falling inflation means prices rising more slowly, not falling, and prices returning to old levels would be deflation, which central banks avoid because it encourages delayed spending and raises the real burden of debt. Core inflation strips out food and energy because they are volatile, not because they do not matter. And moderate inflation around 2 percent is a policy target rather than a failure, chosen to leave room for real interest rates to fall in a downturn and to avoid the deflation trap.