What is inflation? A complete guide to understanding its impact on the economy

Understanding what is inflation goes beyond simply hearing this term repeated in the news or economic debates. Inflation directly influences your purchasing power, the value of your money over time, and even your investment decisions.

Therefore, understanding what is inflation, how it is calculated, its main causes, and the effects it has on the economy is essential for anyone who wants to maintain financial health and plan more securely for the future.

Although inflation is a recurring topic, it is not always clear how this phenomenon really works. After all, why do prices rise? Who is most affected? Are there ways to protect yourself from inflation?

We will answer these and other questions, explaining in a simple and direct way what is inflation, how it affects your daily life, and which strategies can minimize its impacts.

If you want to finally understand what is inflation and its true weight on the economy and your life, keep reading and discover everything you need to know!

What is inflation?

At its core, inflation refers to the increase in prices of goods and services over time, which leads to a decrease in the purchasing power of money.

This means that as inflation rises, each dollar you have buys fewer goods and services than before. For example, if inflation is 2% per year, something that costs $100 today will cost $102 next year.

Inflation can affect everyday goods, including food, gasoline, and housing, and is a key factor in determining the overall health of an economy.

It is a natural economic phenomenon that occurs in virtually all economies. However, when inflation is too high or too low, it can cause significant economic instability.

Central banks, such as the Federal Reserve in the United States, closely monitor inflation to ensure it remains at a healthy level, generally around 2% per year.

How inflation affects prices of goods and services

Inflation does not affect all goods and services equally, but its effects can be felt across all sectors. Prices generally increase over time, meaning items like food, healthcare, and education will likely cost more as years go by.

However, inflation can also cause certain sectors to experience more significant price increases due to supply and demand dynamics, government policies, or market conditions.

One of the most direct impacts of inflation is its ability to increase the cost of living. For example, if wages do not keep up with inflation, workers may find themselves able to afford fewer goods and services than before.

Similarly, if inflation causes housing or rent costs to rise, people may struggle to find affordable places to live. Inflation is a reminder of the importance of budgeting and managing finances effectively, since prices rise and wages need to increase accordingly to maintain purchasing power.

How is inflation measured?

Inflation is measured by tracking the price changes of a basket of goods and services over time.

This basket includes a variety of items, such as food, housing, transportation, and healthcare, which reflect typical household consumption patterns.

The most commonly used inflation measure is the Consumer Price Index (CPI), which calculates the average change in prices paid by urban consumers for a fixed basket of goods and services.

Another important inflation indicator is the Producer Price Index (PPI), which tracks price changes received by producers for their goods and services.

The PPI provides information about inflationary pressures in the early stages of production, while the CPI reflects the final prices paid by consumers.

What is considered high inflation?

In the United States, inflation is considered high when it exceeds a certain threshold, usually around 3% per year.

Central banks aim to keep inflation stable, typically around 2%, to promote economic growth without causing excessive price increases.

When inflation surpasses this level, it may signal an overheating economy, which can lead to a reduction in purchasing power and potential economic instability.

On the other hand, deflation, a drop in the general price level, can be equally problematic.

Although lower prices may seem attractive, deflation often indicates a stagnant or contracting economy, which can lead to job losses and reduced consumer spending.

The Federal Reserve carefully monitors inflation to ensure it remains within a manageable range.

Inflation rate in the U.S.

The annual inflation rate in the United States fell to 2.4% in March 2025, the lowest level since September 2023, down from 2.8% in February and below forecasts of 2.6%.

The drop was mainly driven by a decrease in gasoline prices (9.8%), more than the 3.1% drop in the previous month, and fuel oil (7.6%), exceeding the 5.1% forecast.

On the other hand, natural gas prices rose 9.4%, above the 6% increase recorded in February.

Inflation also slowed in sectors such as housing (4% vs. 4.2%), used cars (0.6% vs. 0.8%), and transportation (3.1% vs. 6%). In contrast, inflation accelerated in the food sector, which rose 3%, above February’s 2.6%.

Compared to the previous month, the CPI fell 0.1%, the first decline since May 2020. The energy index dropped 2.4%, with gasoline (-6.3%) offsetting increases in electricity (+0.9%) and natural gas (+3.6%).

Core inflation fell to 2.8%, the lowest since March 2021, below the forecast of 3%.

Note: These values were current at the time of writing, but may change over time.

What causes inflation?

Inflation can arise from a complex combination of factors, both internal, related to the economic dynamics of the country itself, and external, such as global events or fluctuations in international markets.

Some of the most common causes of inflation involve increased demand for goods and services, rises in production costs, expansion of the money supply, or even external shocks like geopolitical crises or changes in oil prices.

Each of these elements contributes differently to price increases in specific sectors of the economy or more generally.

Below, find a detailed explanation of the main factors that cause inflation, how they work, and why they create lasting impacts on prices and the purchasing power of the population.

Demand-Pull Inflation

This type of inflation occurs when the demand for goods and services exceeds supply, causing prices to rise.

When the economy is expanding, consumers and businesses may spend more money, leading to price increases.

This often happens during periods of rapid economic growth when demand surpasses companies’ production capacity.

Cost-Push Inflation

Cost-push inflation occurs when production costs increase, causing companies to raise prices to maintain profitability.

It happens when prices of essential inputs, such as oil, labor, or raw materials, increase. If production costs rise broadly, the result is a widespread increase in the prices of goods and services.

Built-in Inflation

Built-in inflation, also known as wage-price inflation, occurs when companies raise prices to compensate for higher labor costs.

Workers, seeing prices rise, may demand higher wages, which in turn leads companies to increase prices to cover the increased labor costs.

This creates a feedback loop between wage increases and price increases, establishing an equilibrium to maintain purchasing power.

How can I protect myself from inflation?

Although inflation is an inevitable part of economic life, there are several ways to protect yourself from its effects.

It is possible to adopt strategies to minimize its impact. With organization and knowledge, you can safeguard your finances even in inflationary scenarios.

By being proactive with your personal finances, you can reduce the impact of inflation on your savings and purchasing power. Controlling expenses, investing wisely, and monitoring economic indicators are essential steps.

Protecting yourself from inflation involves planning and conscious decisions. Understanding what inflation is and how it affects your money is the first step to maintaining financial stability.

Keep your money in the right place

The first step to protecting yourself from inflation is to ensure your savings are in the right financial products.

Keeping money in a traditional savings account, for example, will not help you overcome inflation. Instead, consider options like stocks and inflation-protected securities, such as Treasury Inflation-Protected Securities (TIPS).

These investments are designed to track inflation, providing protection against rising prices.

Create a budget

A solid budget is essential for managing inflation’s impact on your finances, so make a budget. Track your expenses and adjust your consumption habits to account for rising prices.

A budget can help you avoid overspending on items affected by inflation and prioritize spending on basic needs.

Shop around for the best prices

Inflation does not affect all products equally. While some items may become significantly more expensive, others may not see large price changes.

Always compare prices before buying, consider switching brands, and take advantage of available discounts.

By shopping smartly, you can reduce the overall impact of inflation on your daily life.

Build an emergency fund

Having a robust emergency fund is crucial to face the effects of inflation, especially if it leads to unexpected financial challenges like job loss or increased living costs.

Try to save enough to cover at least three to six months of expenses. This reserve can help you avoid debt during periods of economic instability driven by inflation.

Inflation is inevitable in the modern economy, and understanding its causes, effects, and how to protect yourself from it is essential to maintain your financial health. Stay alert!

Whether through strategic investments, budgeting, or building an emergency fund, there are steps you can take to minimize inflation’s impact on your finances.

Keep an eye on inflation trends and adjust your financial strategies accordingly. To anticipate inflation and make smarter financial decisions, continue exploring resources and information on how to protect your finances.

If you need to learn more about building your emergency fund, don’t miss this simple and complete guide on our website!