Causes of Inflation

When the economy is healthy and consumers are able to enjoy a rising standard of living, their demand for products grows, which raises the cost of goods and services. Higher prices result in fewer people able or willing to make the same purchases as before, leaving businesses with a surplus of goods. In order to stimulate spending, businesses lower prices. With sufficiently lowered prices comes increased demand, and the cycle begins all over again. Many factors influence inflation, from overall economic conditions and consumer spending to monetary policy and the political outlook.

The economy doesn't always experience increasing rates of inflation. A deceleration in the rate of inflation - from 3% to 2%, for example - is called disinflation. Because 2% is still a positive number, the economy would still be growing in this period. It is deflation, a widespread decline in prices of products and services, that can undermine investor confidence and slow growth in the economy.