Glossary
Inflation
A sustained rise in the general price level, which reduces the purchasing power of money over time.
Inflation is a broad, sustained increase in the prices of goods and services, which means each dollar buys less over time. It is usually expressed as an annual percentage change in a price index. For investors, inflation is the hurdle every return has to clear: a 5% gain in a year of 4% inflation adds only about 1% of real purchasing power. It also drives central-bank policy, interest rates and the valuations of stocks and bonds.
How it is measured in the US
- Consumer Price Index (CPI), from the Bureau of Labor Statistics, tracks a basket of goods and services bought by urban consumers and is released monthly.
- PCE price index, from the Bureau of Economic Analysis, covers a broader range of spending and adjusts more readily as consumers substitute between goods. The Federal Reserve's 2% target is defined in terms of PCE inflation.
- "Core" versions exclude food and energy, whose prices swing widely, to show the underlying trend.
US CPI inflation peaked at 9.1% year over year in June 2022, the highest since 1981.
Causes and effects
Inflation can come from demand outrunning supply, from cost shocks such as energy prices, or from expectations that become self-fulfilling. Moderate, stable inflation is considered healthy; high or volatile inflation erodes savings and fixed incomes and pushes interest rates up, which lowers the value of existing bonds and long-duration stocks. The opposite, a falling price level, is deflation. Treasury Inflation-Protected Securities (TIPS) are one direct hedge.