Inflation explained with everyday examples

By Omid Jamshidi · Published 18 October 2026 · 6 min read

What inflation is, how it is measured, why your own price rise can differ from the official figure, and what it means for savings, wages and loans – explained with simple examples.

Hardly any economic figure appears in the news as often as the inflation rate – and hardly any is felt so directly at the supermarket checkout. This guide explains what the number means, how it is measured, why it often does not match your own experience and what it means for savings, wages and loans. You do not need any background in economics.

What inflation is

Inflation means that prices rise on average over time, so the same amount of money buys less. If the inflation rate is 3 percent, a basket of goods and services that cost 100 a year ago now costs about 103.

"On average" is important. Some prices rise much faster, some stay the same and some even fall – electronics, for example, often get cheaper. Inflation describes the overall trend, not every single price.

The opposite, a general fall in prices, is called deflation. It sounds pleasant, but it can be harmful: when people and companies expect prices to keep falling, they put off purchases and investments, and the economy slows down.

How it is measured: the shopping basket

Statistics offices measure inflation with a "basket" of goods and services that represents what households typically spend money on: food, rent, energy, transport, clothing, leisure and much more. Every month they record the prices of thousands of items and compare the cost of the basket with the same month a year earlier.

Each part of the basket has a weight that reflects its share of household spending. Housing and energy count for much more than, say, coffee. A simple example: if a basket cost 1,000 last year and 1,032 this year, the inflation rate is 3.2 percent – even if the price of coffee in it rose by 20 percent.

In the United States the best-known measure is the Consumer Price Index (CPI). In the euro area, countries publish the Harmonised Index of Consumer Prices (HICP), which follows common rules so the countries can be compared; the UK publishes its own CPI.

Headline and core inflation

News reports often mention two figures. Headline inflation includes everything in the basket. Core inflation leaves out food and energy, whose prices jump up and down with harvests, weather and world markets. Core inflation shows better whether price rises are spreading through the whole economy; headline inflation shows what households actually pay.

Why your own inflation can feel different

The official rate is an average for all households. Your personal rate depends on what you buy:

• If you rent and your rent goes up, your personal inflation can be well above the official figure.
• If you drive a lot, fuel prices hit you harder than someone who cycles.
• Food and energy are bought often and noticed immediately, while rarer purchases with falling prices – a new phone, for example – are easily forgotten.

So when the official rate falls but prices "still feel high", both can be true: a lower rate means prices are rising more slowly, not that they are going back down.

Why prices rise

Economists distinguish several causes, which often act together:

• Demand: when people and companies want to buy more than the economy can produce, sellers can raise prices.
• Costs: when energy, raw materials or wages become more expensive, companies pass part of the cost on to customers.
• Expectations: if everyone expects higher prices, workers ask for higher wages and companies raise prices in advance – which helps make the expectation come true.
• Money and exchange rates: when a currency loses value, imports become more expensive. Over long periods, countries whose money supply grows much faster than their economy usually have high inflation.

What central banks do

Most central banks aim for low and stable inflation, often around 2 percent a year – the US Federal Reserve, the European Central Bank and the Bank of England all use a 2 percent target. Their main tool is the interest rate. Higher rates make loans more expensive and saving more attractive, which cools demand and slows price rises over time; lower rates do the opposite. The effect takes time, often a year or more, which is why central banks look ahead rather than only at the latest figure.

What inflation means for your money

Savings: money that earns no interest loses purchasing power. At 3 percent inflation, 100 in a current account buys only about 74 percent as much after ten years.

Real interest: what counts is the interest rate minus inflation. Savings earning 4 percent while prices rise 3 percent grow by only about 1 percent in real terms. If inflation is higher than the interest rate, the real return is negative.

Wages: a pay rise of 2 percent with 5 percent inflation means you can buy almost 3 percent less than before. That is why wage negotiations look at "real wages".

Loans: for borrowers with a fixed interest rate, inflation is not all bad – the amount owed stays the same while incomes usually rise over time, so the debt becomes lighter in real terms.

A rule of thumb: divide 70 by the inflation rate to estimate how many years it takes for prices to double. At 2 percent it takes about 35 years, at 5 percent about 14 years, at 10 percent about 7 years.

How to read inflation news

• Check whether a report gives the annual rate (compared with the same month a year earlier) or a monthly change – they are easily confused.
• "Inflation is falling" means prices are rising more slowly, not that they are falling.
• Note whether a figure is preliminary: many statistics offices publish a quick estimate first and a final figure later.
• Compare headline and core inflation to see whether a change comes mainly from energy and food.

If you want to work out what inflation means for your own money, the free inflation and compound-interest calculators on FinanzTool.info – another website by the publisher of Omid57.info – can help. The latest economic headlines from several outlets are in the Economy section of this site, and our guide How to read the news critically explains how to check statistics in news reports.

Conclusion

Inflation is an average, not a promise about every price. Knowing how it is measured, why your own experience may differ and how it affects savings, wages and loans makes economic news much easier to follow – and helps you make better decisions with your money.