What Is Inflation?

Inflation is the rate at which the general level of prices for goods and services rises, causing purchasing power to fall. When inflation is 3%, something that costs $100 today will cost $103 next year. The primary measure of U.S. inflation is the Consumer Price Index (CPI), which tracks the price changes of a basket of goods and services that typical households buy.

Moderate inflation (around 2% per year) is considered healthy and is the Federal Reserve's explicit target. It encourages spending and investment because money sitting idle loses value. However, high inflation (above 5-6%) erodes savings, makes planning difficult, and disproportionately hurts people on fixed incomes. The U.S. experienced its highest recent inflation spike in 2022 at 9.1%, the highest in 40 years.

Inflation can be caused by excess demand (too many dollars chasing too few goods), supply chain disruptions, rising energy costs, or expansion of the money supply. The Federal Reserve combats inflation by raising interest rates, which makes borrowing more expensive and slows economic activity.