A measure of how much prices rise over time. The higher the inflation rate, the lower your purchasing power will be over time. Inflation affects everyone: consumers, businesses, people on fixed incomes, borrowers, and lenders. People track the price of goods and services, companies think about how much to raise their prices, and borrowers worry about repaying loans that are worth less in real terms.
Inflation is measured using a combination of several data sources and techniques. A key component is a “basket” of goods and services, for which each unit price change is weighted by how much the average consumer buys. That gives the most accurate picture possible of how prices are changing overall. New products are added to the marketplace over time that may not be reflected in existing price indices, and the quality of existing items changes as well.
One of the most common measures is the Consumer Price Index, or CPI. The CPI is calculated by surveying households to learn what percentage of their spending goes toward each good or service, and then weights the average price for each item accordingly. Various other economic data are used to calculate inflation as well, and the calculation can be complex because, for example, the price of oil is so volatile that it needs to be excluded from certain calculations.
The Federal Reserve, which sets national monetary policy, is committed to achieving a low and stable rate of inflation. Inflation that is both low and stable makes it easier for businesses and individuals to make sound decisions about saving, borrowing, and investing, and contributes to a healthy economy.