Inflation is the rate at which the general level of prices for goods and services increases over time, eroding purchasing power and affecting economic activity. Measured through various indices like Consumer Price Index (CPI) and Producer Price Index (PPI), inflation significantly impacts monetary policy decisions, interest rates, and asset prices across financial markets.

Central banks typically target moderate inflation levels (around 2% annually) to promote economic stability while avoiding deflation risks. High inflation often leads to higher interest rates, affecting bond prices, currency values, and equity valuations. Commodities and inflation-protected securities often benefit from rising inflation expectations, while fixed-income investments suffer from eroded real returns.

Real-world example: Annual inflation rising from 2% to 5% causes Treasury bond prices to decline and yields to rise as investors demand higher returns to compensate for increased inflation risk, while commodity prices rally.