The inflation rate measures how much prices rise over time. The higher the inflation rate, the more purchasing power your money loses over time. It’s important to be aware of inflation rates because they can affect your budget, investments and spending.
To measure inflation, statistical agencies compare the cost of a “basket” of goods and services to a previous period of time. The Bureau of Labor Statistics assigns different weights to each good or service in the basket, based on how much it’s typically purchased by households. For example, the price of books and childcare are given a smaller weight in the basket than the price of eggs or car insurance. Then, by subtracting the price of a good or service from the previous version and multiplying it by 100, you can find the inflation rate.
This is known as the consumer price index, or CPI. It’s the most common method for measuring inflation. You can use this formula to calculate inflation over any time span, whether it’s a month to a month, quarter to a quarter or year to a year.
Another popular way to measure inflation is with a core price index, which removes the most volatile components of an overall price index like food and oil. Core inflation is less influenced by short-term fluctuations in these commodities, making it better suited to tracking long-term trends.
If inflation is too high, it can cause economic problems by making it harder for borrowers to service their debt. The opposite of inflation is deflation, which can also lead to financial problems because it makes debt repayments more expensive in real terms. Inflation between 2% and 4% is generally considered healthy because it can boost consumer spending and economic growth.