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Inflation: 3 Important Things to Know

A woman sits among inflated balloons.

Inflation is, for better or worse, on everyone’s minds. As a quick refresher, inflation refers to the natural tendency of prices to rise over time. Usually, prices rise slowly — the Federal Reserve aims for annual 2% inflation, which means that average prices should go up only 2% per year.

At that rate, most consumers don’t really notice or feel their money losing value. But over time, it adds up. That’s why older people may reminisce about the days when they could buy a Coca-Cola for a nickel, or when gas cost $0.50 per gallon.

But inflation has risen much faster of late, for a number of reasons. The pandemic was the single biggest cause, which brought on supply chain problems, labor issues, and numerous rounds of stimulus in the U.S. and around the world. It’s a big mess, there’s no getting around it, and prices have risen faster, as a result, than they have in decades.

There are some important things to keep in mind about inflation, though, as the conversation continues. You’ll likely see many headlines about inflation, so you’ll want to know exactly what is being discussed. Here are a few key things to know:

1. Inflation is measured by the CPI

The Consumer Price Index, or CPI, is a measure of prices. It looks at a basket of consumer goods and services (like transportation, food, etc.) and tracks the changes in prices every month. It helps economists and policymakers track inflation, in other words.

So, when you hear someone say that the “CPI was up 3% this month,” that’s what they’re referring to. There are several sub-measures within the CPI as well, which look at subsets of goods, and even seasonally-adjusted prices. The CPI is reported by the Bureau of Labor Statistics on a monthly basis, going all the way back to 1913. 

2. Inflation is Measured Year-Over-Year

Have you seen a headline that read something like this?: “CPI increases 7.9% in January”

That makes it sound like prices increased almost 8% between December and January, doesn’t it? It’s a bit misleading because what the headline actually means is that the CPI is up 7.9% over the past year — the numbers are measured year-over-year. While a 7.9% increase in the CPI over a year isn’t a good thing either, it’s a lot better than prices jumping 8% in just a few weeks.

3. The causes are more complicated than you think

Inflation is hard to pin down. You’ll hear many people blaming inflation for, well, whatever they want to blame it on. But the truth is that inflation occurs naturally and is a sign of a healthy economy. Again, the Fed even accounts and aims for a low level of annual inflation.

But most recently, the causes of high inflation mostly have to do with the pandemic, and our response to it. The price of computer chips, for example, shot up, causing a shortage of new cars, and thus, a spike in new car prices. That affects the CPI. 

We also haven’t been building enough new homes, meaning that the price of existing homes has shot up, too. Again, more inflation. And stimulus measures can’t be overlooked, either. But it’s hard to say to what degree any one thing had on the overall inflation rate. It’s a complicated mosaic.

But by keeping these things in mind, you’ll be better equipped to handle how and when the news reports on inflation, and hopefully, have a better grasp of how to handle it.

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