What inflation is
Inflation is the rate at which the general level of prices in an economy rises over time. If inflation is 5%, something that cost £100 last year costs £105 now. Deflation — falling prices — sounds good but is economically dangerous: if prices are expected to fall, consumers delay purchases, which reduces demand and can trigger a deflationary spiral.
Why some inflation is considered healthy
Most central banks, including the Bank of England, target 2% annual inflation. This provides a small buffer against deflation and gives policymakers room to cut interest rates in a recession.
What causes inflation
The main causes are demand-pull (too much money chasing too few goods, often in economic booms), cost-push (rising energy prices, raw materials or labour costs passed on as higher prices), imported inflation (a weaker exchange rate makes imports more expensive) and expectations (if businesses and workers expect high inflation, they raise prices and demand higher wages, making the expectation self-fulfilling).
The tools for controlling it
Central banks control inflation primarily through interest rates. Higher rates increase the cost of borrowing, reducing consumer spending and business investment, which reduces demand. This is effective but blunt — it can tip the economy into recession if rates are raised too aggressively.