The inflation rate measures how quickly prices rise. It is a crucial piece of information for consumers, businesses, individuals on fixed incomes, and lenders and borrowers. A high rate of inflation can make it more difficult to pay bills, purchase goods or services and save money. It also distorts vital relative-price signals, causing people to spend time and resources in activities that may not support productive economic growth or wealth.
The official measure of inflation in the United States is the Consumer Price Index (CPI). Each month statisticians check the prices of a basket of 700 different items that are used to represent average household expenditures, including food, transportation and housing costs. They then compare that basket’s price changes from one period to the next to calculate a monthly or annual rate of change in prices, respectively.
This method of measuring inflation has its problems, though. The basket is not a perfect representation of how people spend their money, and it excludes certain types of spending (like savings). In addition, the CPI is weighted so that if an individual good spikes in price, such as the cost of beef or veal, that will raise the overall inflation rate even if other prices decline. A more accurate measure of inflation is the Personal Consumption Expenditures (PCE) Price Index, which is calculated using more extensive and varied data than the CPI.
There are many causes of inflation, but the most important is how and where new money enters the economy. For example, tight labor markets – as measured by the ratio of job openings to unemployment – can cause wage pressures that eventually raise prices across the economy. This type of inflation is called demand-pull inflation.