What Is Inflation?
Inflation is an increase in the average price of goods or services in an economy. Each month, the Bureau of Labor Statistics reports on the average level of prices when it releases the Consumer Price Index (CPI). Inflation is measured as the percentage increase in average level of prices over a select period of time.
In a stable economy, an average inflation rate is typically around 2%.
You can use an inflation calculator to see the purchasing power of the U.S. dollar and how it has changed over the years. With this tool, you can even see how much the price of something today would have cost in any year back to 1913.
Is Inflation Good or Bad for the Economy?
Inflation can be viewed as positive for the economy, assuming it is not rising too quickly. Inflation can be a good indicator of consumer demand for goods and services, which in turn creates an increase in need and opportunity for labor in the workforce. The resulting spending and earning of this money drives economic growth.
Inflation can also be viewed negatively, especially if it leads to hyperinflation, which means that prices are rising faster than wages. This creates an economic imbalance with workers able to afford less even though they may theoretically be working more.
If inflation gets too high, the federal reserve will increase interest rates to tighten financial conditions, reduce demand for borrowing and prevent upward spiraling prices.
How Does Inflation Work?
Inflation is impacted by the balance of supply and demand in the economy. A surge in demand for products or services typically leads to higher prices, which can be followed by increased production. Similarly, shortages of certain inputs can increase prices as there will be a reduced supply of goods.
For example, there was a large increase in demand for home modification and home improvement projects over the last year. This caused the price of lumber and manual labor to jump and forced consumers to pay more. Each dollar spent on lumber, for example, bought less and less than in prior years.