Inflation, explained in plain language
In 30 seconds. Inflation is the pace at which prices rise across the whole economy. When officials say inflation is 3 percent, they mean a standard basket of goods and services costs about 3 percent more than a year ago.
Key points
- Inflation is a general rise in prices, not one expensive item.
- The best known measure is the Consumer Price Index, published monthly by the Bureau of Labor Statistics.
- The Federal Reserve aims for 2 percent inflation over time, measured by a related index called PCE.
- Your personal inflation rate differs from the headline number, because every household buys different things.
What happened
Every month one number moves markets, rent negotiations and election arguments: the inflation rate. It is quoted constantly and defined rarely, which is why the same report can produce opposite headlines.
How it is measured
The Bureau of Labor Statistics tracks prices for a basket of goods and services that represents typical urban spending: food, housing, energy, vehicles, health care and more. The Consumer Price Index compares the basket's cost with earlier periods. The 12 month change is the headline inflation rate.
Why the Fed targets 2 percent
The Federal Reserve's job includes keeping prices stable. It defines that as inflation averaging 2 percent over time, using the PCE price index, which weights spending a little differently from the CPI. A small positive target gives the economy a cushion against deflation, a spiral of falling prices that encourages people to delay spending and can deepen recessions.
Why it matters
Inflation quietly sets the value of wages, savings and debts. Pay that rises slower than prices is a real pay cut. At the same time, the Fed fights inflation mainly by raising interest rates, which makes mortgages, car loans and credit cards more expensive. That trade off is the central tension in almost every inflation story.
What happens next
In any inflation report, look past the headline to two details: the monthly change in core inflation, which removes food and energy, and shelter costs, which move slowly and carry heavy weight. Those two lines usually decide whether the Fed feels it is winning.
U.S. Bureau of Labor Statistics, Consumer Price Index program documentation; Federal Reserve, monetary policy framework and 2 percent target statement. Linked in full at publication.