The value of your money depends on what you
can buy with it and this is determined by the prices you pay for things.
The more people want something, the higher the price will become and the more easily
available something is, the cheaper it becomes. This adjustment in prices in response to supply
and demand goes on all the time throughout the economy. Some prices rise, some fall.
That’s normal. However, if there’s too much money in the
economy as a whole, with spenders wanting to buy more things than can be produced, then
everything can start to cost more: demand outstrips supply; prices in general rise and
the value of money decreases. That’s inflation. We start to save less and spend more because
we think that our money will buy less tomorrow. We also need to be paid more to maintain our
standard of living, which increases the costs to businesses forcing up prices still further.
A spiral of rising costs and prices can develop. With high inflation, it’s hard to compare
prices. The market economy no longer operates effectively. The value of savings is also
eroded and companies become reluctant to plan ahead, to invest or create jobs.
The same thing can happen in reverse when people spend too little – supply outstrips
demand; prices tend to fall. People wait for prices to fall further which makes prices
spiral downwards. This is deflation. Both circumstances are bad for the economy,
business and people. It is the Bank of England’s job to keep prices
stable, maintaining the value of our money.