Inflation is gradual increase in the level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every Rupee you own buys a smaller percentage of a good or service.
The variables which are influenced by inflation are interest rate, exchange rate exports, imports and unemployment. However, the biggest influence is inflation on interest rates. In situations of high inflation interest rate is raised to control inflation and vice-versa. Inflation directly effects exchange rate by reducing the value of currency. It indirectly effects it through interest rates. There is an inverse relationship between inflation and unemployment given by the Phillips Curve.High economic activity leads to more demand more jobs and hence higher inflation. The effect of inflation is not well-established on exports. Inflation makes imports more expensive through depreciation of home currency.