An inflation rate is a measure of how quickly prices for consumer goods and services are increasing. It’s closely watched by policymakers, such as the Federal Reserve, who seek to keep inflation in a healthy range. Inflation can have a big impact on people and businesses who have savings or assets that are valued in terms of their purchasing power. Keeping inflation in an optimum range encourages people and businesses to spend now instead of saving for later, which can boost economic activity.
An optimum level of inflation is usually thought to be one that is just below or slightly above a country’s average wage, so that workers can easily afford the prices of everyday items and services without needing to increase their spending beyond what they normally would. Inflation may also cause a loss of purchasing power for assets that are valued in a country’s currency, such as cash or bonds.
There are two broad kinds of inflation: headline and core. Headline inflation tracks price changes in a “basket of goods” meant to reflect the actual spending habits of consumers, while core consumer inflation excludes certain volatile categories like food and energy that can be affected by seasonal factors or temporary supply conditions. Core inflation gives a better picture of long-term price trends and is a focus of Federal Reserve policymaking.
Built-in inflation occurs when new money and credit enters the economy and causes prices and wages to rise, then eventually work their way through the entire production process. This creates a cycle where higher prices lead to higher wages, which in turn leads to even higher prices.