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Inflation defined: What to know about causes, hyperinflation

what is the definition of inflation?

This approach is less influenced by a month with a particularly small or large change but both ways of reporting changes in the CPI are accurate. The Consumer Price Index (CPI), produced by the Bureau of Labor Statistics (BLS), is the most widely used measure of inflation. The primary CPI (CPI-U) is designed to measure price changes faced by urban consumers, who represent 93% of the U.S. population. It’s an average, though, and doesn’t reflect any particular consumer’s experience. Inflation is the decline of purchasing power in an economy caused by rising prices, according to Investopedia. In January 2022, inflation in the United States accelerated to 7.5 percent, its highest level since February 1982, as a result of soaring energy costs, labor mismatches, and supply disruptions.

The Fed has only done this during economic emergencies such as the Great Recession and the COVID-19 pandemic. When the Fed buys assets, it adds money to the economy by freeing up banks to make more loans to people or businesses. When the economy recovers and inflation rises, the Fed can then sell those assets, reducing money in the economy. Inflation refers to the general increase in prices or the money supply, both of which can cause the purchasing power of a currency to decline. This means that, like the chained CPI, the PCE is better at accounting for substitutions between similar items when one of them becomes more expensive. Because its formula uses updated data, the PCE is believed to be a more accurate reflection of price changes over time and across items.

A country’s financial regulator shoulders the important responsibility of keeping inflation in check. It is done by implementing measures through monetary policy, which refers to the actions of a central bank or other committees that determine the size and rate of growth of the money supply. As long as banks only issue a dollar in exchange for assets worth at least a dollar, the issuing bank’s assets will naturally move in step with its issuance of money, and the money will hold its value. Should the bank fail to get or maintain assets of adequate value, then the bank’s money will lose value, just as any financial security will lose value if its asset backing diminishes. The real bills doctrine (also known as the backing theory) thus asserts that inflation results when money outruns its issuer’s assets. The quantity theory of money, in contrast, claims that inflation results when money outruns the economy’s production of goods.

Understanding Inflation

For example, new versions of the iPhone are introduced to the market on a regular basis. The iPhone someone buys today is of better quality than the one bought five years ago. In addition, entirely new goods are sometimes introduced that might make people much better off. A slowdown in inflation is called disinflation and a reduction in prices is called deflation.

Essentially, if you purchased a basket of goods and services (as included in the CPI definition) worth $10,000 in 1975, the same basket would cost you $59,197 in January 2024. Depending upon the selected set of goods and services used, multiple types of baskets of goods are calculated and tracked as price indexes. The most commonly used price indexes are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI). USAFacts is a not-for-profit, nonpartisan civic initiative making government data easy for all Americans to access and understand.

  1. To understand the effects of inflation, take a commonly consumed item and compare its price from one period with another.
  2. If you have a specific recommendation, you can reach us at [email protected].
  3. The Federal Reserve clearly communicates long-term inflation goals in order to keep a steady long-term rate of inflation, which is thought to be beneficial to the economy.
  4. Lower interest rates tend to encourage spending and business investment, which also stimulates the velocity of money.

The overall CPI, also known as “headline” CPI, is measured by the percent change in these categories from one period to another. Since food and energy categories are typically much more volatile than the other parts of the CPI, economists often focus more on a metric called the “core” CPI which excludes these two categories. The primary CPI can overstate inflation because it prices the same basket of goods from one month to the next (although items are updated every two years), and it doesn’t take into account substitutions between similar goods.

Time and resources expended on researching, estimating, and adjusting economic behavior are expected to rise to the general level of prices. That’s opposed to real economic fundamentals, which inevitably represent a cost to the economy as a whole. Businesses, workers, and consumers must all account for the effects of generally rising prices in their buying, selling, and planning decisions.

How does inflation today differ from historical inflation?

Companies that pay higher wholesale costs and don’t raise customer prices risk a decline in profit margins. That’s why a rise in PPI is often soon followed by a rise in CPI as companies accept the inevitable and ask their customers to help foot the bill for pricier shipping or raw materials. The Federal Reserve typically focuses on a different measure of inflation than CPI-U called the Personal Consumption Expenditures (PCE) price index. It also relies on a market basket of items, but instead focuses on what businesses are selling. Inflation as measured by the core CPI-U is typically about half a percentage point higher than the PCE. Quantitative easing is when the Fed trades in assets backed by the Treasury Department.

what is the definition of inflation?

The nations that were victorious in World War I demanded reparations from Germany, which could not be paid in German paper currency, as this was of suspect value due to government borrowing. Germany attempted to print paper notes, buy foreign currency with them, and use that to pay their debts. One can also opt for a TIPS mutual fund or TIPS-based exchange-traded fund (ETF).

Continue to track inflation and other indicators for economic recovery at the USAFacts Impact and Recovery Hub. Sign up on our mailing list here to be the first to know when it is available. We frequently add data and we’re interested in what would be useful to people. If you have a specific recommendation, you can reach us at [email protected]. The Cleveland Fed also posts a median PCE price index, and the Dallas Fed posts a trimmed-mean version.

This is especially evident when there’s a negative economic shock to the supply of key commodities. Theoretically, monetarism is a popular theory that explains the relationship between inflation and the money supply of an economy. For example, following the Spanish conquest of the Aztec and Inca empires, massive amounts of gold and silver flowed into the Spanish and other European economies.

Fear of Fed tightening tends to hurt stocks, and falling stock prices can make investors and companies nervous and less likely to spend, slowing the economy. Now envision this happening every day across the country among millions of consumers and businesses. Consumer spending accounts for about 70% of U.S. gross domestic product (GDP), and can be a major force to stimulate economic growth. The gold standard is a monetary system in which a region’s common medium of exchange is paper notes (or other monetary token) that are normally freely convertible into pre-set, fixed quantities of gold. The standard specifies how the gold backing would be implemented, including the amount of specie per currency unit.

Effects of inflation

To get access to stocks, ETFs, and other funds that can help avoid the dangers of inflation, you’ll likely need a brokerage account. Choosing a stockbroker can be a tedious process due to the variety among them. Hyperinflation is often described as a period of inflation of 50% or more per month. As such, investors looking to protect their portfolios from inflation should consider inflation-hedged asset classes, such as gold, commodities, and real estate investment trusts (REITs). Inflation-indexed bonds are another popular option for investors to profit from inflation.

The CPI is broken down by regions and is reported for the country as a whole. The Personal Consumption Expenditures (PCE) price index—published by the US government’s Bureau of Economic Analysis—takes into account a broader range of consumers’ expenditures, including healthcare. In 2022, inflation rates around the world rose to their highest levels since the early 1980s. While there is no single reason for this rapid rise in global prices, a series of events worked together to boost inflation to such high levels.

Many economists advocate for a middle ground of low to moderate inflation, of around 2% per year. Some critics of the program alleged it would cause a spike in inflation in the U.S. dollar, but inflation peaked in 2007 and declined steadily over the next eight years. There are many complex reasons why QE didn’t lead to inflation or hyperinflation, though the simplest explanation is that the recession itself was a very prominent deflationary environment, and quantitative easing supported its effects. Economists, in general, understand that distortions of relative prices away from their economic equilibrium are not good for the economy, and Austrian economists even believe this process to be a major driver of cycles of recession in the economy. Buyers of such assets may not be happy with inflation, as they will be required to shell out more money.


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