The inflation rate measures the change in prices for a basket of goods and services, typically over a period of time such as a year. Statistical agencies produce price indices to help track overall price trends in the economy, including consumer prices, producer prices, or core consumer inflation (which excludes the impact of changes in energy and food prices). The inflation rate is key to understanding how much it costs to live, work, and invest.
The drivers of inflation vary and can be either short- or long-term in nature. For example, oil shocks or temporary increases in government spending can lead to short bouts of inflation. But sustained periods of high inflation can result in hard-to-control “spirals” where the rise in one product’s price feeds the subsequent rise in the prices for other products. This is known as cost-push inflation.
It’s important to understand the impact of inflation because, as it happens, our purchasing power erodes. When prices rise rapidly, it can make it difficult to meet financial goals like saving for retirement or paying for children’s college education. And although we may earn interest on the money in our savings accounts, it usually doesn’t keep pace with inflation.
Inflation also distorts relative price signals, which can lead people to misallocate resources in a way that can hinder productivity and growth. So it’s crucial for investors to consider the impact of inflation when building their investment portfolios and creating plans for achieving financial goals.