The UK economy was once characetrised by high inflation, which affected the economic stability of the country (Bank of England, 2004). Inflation is defined as the change in consumer prices index (CPI) from the exact period the previous year. The CPI on the other hand is defined as a measure used by governments to measure the change in prices of specific goods and services. Some of the products and services included in CPI measurements include cost of transportation, food, electricity and housing among others. In the 1970s, inflation was at an average of 13 percent a year and reached its peak in 1975 when it hit the 27 percent mark. In the 1980s, the prices were fairly stable and inflation was at an average of 7 percent a year. Though this is not the case anymore, the country is yet to come up with a macroeconomic policy that will ensure that prices remain stable within set inflation targets. According to the bank, the target inflation is 2.0 percent, while the prevailing rate is at 3.0 percent. In February 2010, inflation rose to 3.5 percent and the Bank of England explained that government’s action to restore value added tax to 17.5 percent influenced and led to an increase in inflation. The government had reduced VAT to 15 percent in a bid to encourage consumer spending during the 2008-2009 recession. Causes of inflation According to the Bank of England (2004), inflation occurs when the demand exceeds the ability by the economy’s capacity to produce goods and services. When this is the case, the prices rise in response to the increasing demand. With an increase in the supply of money, this automatically leads to inflation. According to Sloman (2007), excess demand in goods and services leads to demand-pull inflation. The main causes of demand-pull inflation in the UK includes: 1) depreciation of the sterling pound’s exchange rate; 2)reduction in taxation, therefore allowing consumers to have more money to spend;3)increased liquidity in the market especially when banks increase their lending to people and institutions; 4)a rise in consumer confidence especially in the real estate industry; 5) increase of asset prices ; and 6) economic growth in UK trading partner economies thus providing a ready market to the UK exports. A different kind of inflation is the cost-push inflation (Sloman, 2007). Such is caused by external shock to the UK economy, such as fluctuations in commodity prices; depreciation of the sterling pound exchange rate; and /or the increase of unit labour costs or wages. When cost-push inflation occurs, firms usually respond by raising prices for goods and services in order to protect their bottom lines. Effects of inflation One of the most notable consequences of inflation is that money loses value (Sloman, 2007). As a result, people no longer have as much confidence in their currency, and usually this leads to a reduction in savings as people opt to invest in assets hoping that such will give them real value. As one would expect, when the prices of goods and services increase, people have to find a way of maintaining their living standards. Usually, this leads to wage increase demands. Employees who cannot bargain wage increases usually end up liv