The rate of inflation is generally taken to mean the prevailing annual increase of the average level of prices of consumer goods and services in the country. It is generally agreed that a high or volatile inflation rate is a major economic ill. The problems that arise when inflation is high, or volatile and unpredictable, include distortions of income distribution, bias in investment decisions and inefficient allocation of resources. The control of inflation is therefore an issue of primary concern for policy.

A number of different markets are involved in determining the rate of inflation: including the market in goods and services, the labour market, the foreign exchange market and world markets for primary commodities and for finished goods. The process by which prices are set is somewhat different in each one. To understand fully the nature of the inflation spiral it is necessary to understand the processes determining price setting in each. The current price level and the going rate of inflation will both be taken into account when prices are set: this is called the 'no money illusion'. The resulting pressures in the economy lead t rapid rises in world prices of primary commodities, overheating in domestic consumer markets and various imperfections in domestic markets.

Policies for preventing high inflation include restructuring an inflationary labour, market, preventing bottlenecks occurring, a voiding damage to productive capacity and avoiding inflation rates significantly higher than those of trading partners. There is some potential for offsetting temporary inflationary pressures through manipulation of the exchange rate.

The choice of policy options for the cure of inflation is limited. Macroeconomic policies can have a substantial impact on the rate of inflation, but only in certain circumstances will these lead to a persisting reduction in inflation. Government intervention in the operation of the labour market can also influence the rate of inflation.