The inflation rate is the measure of price increases in a basket of goods and services consumed by households. It is a key factor that influences how much your money can buy in the future, and is important to consider when creating your financial plan.
Inflation occurs when the economy grows faster than it can produce goods and services, causing prices to rise. The opposite of inflation is deflation, which causes prices to decline.
To determine a country’s inflation rate, statisticians create a basket of items that represent the types of goods and services used by households. These items are purchased on a regular basis, such as groceries or utilities, and are tracked over time to see how the price of these items changes. Typically, the basket is updated every year to ensure that its items remain relevant.
This allows statisticians to measure the overall impact of price changes on a diversified set of products and services, which can be difficult to do with just one product or service. As such, the Bureau of Labor Statistics uses an index called the Consumer Price Index (CPI) to calculate the inflation rate. Other indices, such as the Personal Consumption Expenditures (PCE) index created by the Federal Reserve, also measure inflation and use different baskets of goods and services.
Inflation can be a good thing, as it can stimulate economic growth by encouraging consumers to spend more in order to get the goods and services they want. However, it can be dangerous when it is too high, as it can lead to higher interest rates and reduced purchasing power. Those on fixed incomes, such as retirees who receive Social Security benefits, can struggle with this type of inflation since their money won’t stretch as far as it once did.