Inflation GapFill

Inflation is a key measure of economic performance. It is important that you are familiar with different types of inflation, how inflation is calculated, the causes of inflation and the effects of inflation.

There are three different types of inflation. The first, when prices are rising, is what we know as  inflationdisinflationdeflationdemand-pull inflation. The second, when prices are rising but at a slowing rate, is known as  deflationdisinflationinflationdemand-pull inflation. The third, when prices are reducing, is known as  disinflationdeflationinflationdemand-pull inflation.

In the UK, inflation is measured by assessing the price level of a 'shopping basket' of key goods and services commonly purchased by consumers. Through this process a weighted average is produced, which can then be compared over time. This measurement process is known as the  consumer price indexgross domestic productpurchasing power parityretail price index. It produces a monthly figure, and the difference between each of these figures is known as the rate of inflation. A similar measure, the  purchasing power parityconsumer price indexretail price indexgross domestic product, was commonly used in the past; however, it is no longer used as the primary measure of inflation in the UK.

Two primary causes of inflation can be identified. The first is the result of costs increasing in the production process which are then passed onto the consumer as price rises. This is known as  wage inflationdisinflationdemand-pull inflationcost-push inflation. The second is the result of rising levels of aggregate demand in the economy, which is known as  disinflationdemand-pull inflationwage inflationcost-push inflation. The UK has a target annual inflation rate of  1%2%1.5%0.5%, and it is the responsibility of the Bank of England to maintain this rate of inflation using  demand-side policiesmonetary policysupply-side policiesfiscal policy.