What does inflation refer to in relation to money?

Inflation refers to a gradual reduction of purchasing power over time. When inflation occurs, the value of currency diminishes, meaning that consumers will need more money to purchase the same goods and services than they would have in the past. This decline in purchasing power can significantly impact the economy, as it affects consumers' ability to buy essentials and influences savings and investments.

Understanding inflation is crucial for various financial aspects, such as setting interest rates, making investment decisions, and planning for future financial goals. Inflation can be measured through various indices, such as the Consumer Price Index (CPI), which tracks changes in the prices of a basket of goods and services over time. This insight into inflation helps individuals and businesses make informed decisions in managing their finances, especially concerning long-term investments and borrowing.