The price of goods and services rises during inflation, reducing the purchasing power of the dollar. For example, a cup of coffee might cost 25 cents in 1970 but $1.59 in 2019—that’s a lot more dollars needed to purchase the same good. Inflation can make it harder for businesses to meet customer demand. It can also stunt economic growth, as households reduce spending and businesses cut costs.
Inflation is typically measured using a price index. These are created by collecting data on a “basket” of items purchased by households, then weighting each individual item’s price change based on its relative share of the total basket. This produces a weighted average of the overall price index, which is then reported as a percentage change from a base year like 1913. Inflation can be caused by a variety of factors, including increased government spending or excessive printing of money. These may only lead to short bouts of inflation, or can feed a spiral of rising prices that becomes hard to stop.
McKinsey’s research has shown that inflation can have a wide range of negative impacts on business and society. Inflation can distort price signals, making investment and hiring decisions more difficult. It can also make it hard for companies to pass on cost increases to consumers, leading to profit declines. Moreover, high inflation increases the noise in the financial system, which makes it more difficult for people to understand what’s happening.
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