The inflation rate measures how much prices rise over time. It’s a key figure central banks watch because it influences purchasing power for consumers, the cost of goods and services for businesses and the interest rates on loans. It’s also important for companies to track because it can affect the price of raw materials, labor and production costs.
The way economists measure inflation is by comparing the prices of a “basket” of goods and services that most people use on a regular basis, such as food, housing, apparel, medical care, transportation, education and communication. This is known as a consumer price index (CPI). Other indices, such as the Personal Consumption Expenditures price index (PCE), published by the U.S. Bureau of Economic Analysis, take a wider range of items into account than the CPI basket.
High or unpredictable inflation can damage a country’s economy, because it makes it difficult for companies to plan long-term. It can also distort investment and savings decisions because people don’t know how far their money will stretch in the future. For these reasons, central bankers generally try to keep the inflation rate at a moderate level.
How inflation affects individuals can differ widely based on their income levels and how they spend their money. For example, the poor often struggle with higher inflation because they spend a greater proportion of their incomes on essentials like food and utilities. They may also be less likely to have assets like stocks or real estate that can help them offset the effects of inflation. In contrast, the rich typically gain from higher inflation because their incomes can buy more than they did before and their wealth grows in real terms.
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