Inflation can have a wide-ranging impact on the economy, from reducing people’s purchasing power to raising or lowering interest rates on the national debt. Understanding and managing inflation is an important element of economic growth and sustainable financial markets.
Essentially, the inflation rate measures how much prices are rising each year relative to the amount of money that’s available. The Federal Reserve aims for a 2% inflation rate over the long term, believing that slow and steady price increases are more effective at encouraging business activity than sharp spikes in pricing.
The most common measurement of inflation is the Consumer Price Index (CPI), which takes a broad look at specific subsets of the population’s spending habits to reflect the average cost of goods and services in the country. Inflation can also be measured on a more targeted basis by looking at the core price index, which excludes certain volatile categories like food and oil, in order to provide a more accurate picture of long run price trends.
Inflation can be a good or bad thing, depending on its speed and what it means for real-world purchasing power. For example, consumers may not mind a low-level of inflation that allows them to buy more for the same dollars. However, businesses that have fixed costs like utilities or raw materials may struggle to keep their prices stable as inflation erodes their profitability.