Falling inflation, yet rising prices: how does that work?
Inflation is going down, but prices keep going up. How is that possible? You might think lower inflation means everything gets cheaper. That’s not true. Inflation and price levels are two very different things.
Inflation, deflation and prices explained
The word “price” simply means what something costs. "Inflation" measures how much prices have changed compared to an earlier point in time, expressed as a percentage. So inflation is not about the price level itself; it is about the average increase or decrease in prices across a country. When inflation falls, it doesn’t mean prices are dropping. It just means they are rising more slowly.
Prices only fall when inflation for a product or service is negative: below 0%. That is called deflation. Why deflation is harmful for the economy, you will read later in this article.
Take the price of bread as an example. If a loaf cost €2.50 last year and €2.70 this year, that is an 8% increase. Inflation for bread this year is 8%. If next year the same loaf costs €2.75, inflation is 2% (see Figure 1). Inflation drops from 8% to 2%, but the bread still costs more. Prices keep rising, just less sharply.
© DNB
The average does not tell the whole story
At DNB, we focus on the overall inflation rate: the average price change for all goods and services in the Netherlands, as measured by Statistics Netherlands (CBS). When the average inflation rate falls, prices rise more slowly on average. But this says little about individual products and services. Average inflation across all products and services in the Netherlands may fall, while inflation across some products and services may be higher or lower than average. Take coffee as an example. Average inflation is falling, but inflation on coffee has risen quite a bit in recent months, so coffee prices are actually rising faster than a year ago. In short, the average does not give a complete picture of price changes of individual products.
Why does this matter?
Central banks like DNB aim for price stability, which means keeping inflation stable around 2%. The goal is for prices to rise slightly, but not too fast.
What are the downsides of deflation?
Deflation – falling prices – sounds appealing but can actually harm the economy. If people expect prices to drop in the near future, they will delay their purchases. That hurts businesses, reduces revenue and discourages investment.
That is why a little inflation is healthy: it encourages people to buy now rather than later – like that new washing machine – because waiting likely means paying more. It also helps firms to invest and raise wages in line with inflation. In short, moderate inflation acts as the lubricant that keeps the economic engine running.