Inflation
Inflation is the rate at which the general level of prices for goods and services rises over time, decreasing the purchasing power of money.
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Inflation erodes purchasing power. Fixed income suffers most. Fed targets 2% inflation.
What is Inflation?
Inflation is the gradual increase in prices and the corresponding decrease in the purchasing power of money. When inflation rises, each dollar buys fewer goods and services than before.
Measuring Inflation
| Measure | What It Tracks |
|---|---|
| CPI (Consumer Price Index) | Prices paid by urban consumers for goods and services |
| PPI (Producer Price Index) | Prices received by domestic producers |
| PCE (Personal Consumption Expenditures) | Fed's preferred measure |
Types of Inflation
| Type | Cause | Example |
|---|---|---|
| Demand-Pull | Too much money chasing too few goods | Economic boom |
| Cost-Push | Rising production costs | Oil price spike |
| Built-In | Wage-price spiral | Workers demand raises expecting inflation |
Effects on Investments
| Asset Type | Impact of Inflation |
|---|---|
| Cash/Savings | Loses purchasing power |
| Bonds | Value decreases (fixed payments worth less) |
| Stocks | Mixed (companies can raise prices, but costs rise too) |
| Real Estate | Often hedges against inflation |
| TIPS | Designed to protect against inflation |
Inflation and Interest Rates
The Federal Reserve raises interest rates to combat high inflation and lowers them to stimulate growth when inflation is low.
Historical Context
| Period | Inflation Rate |
|---|---|
| Long-term average (US) | ~3% annually |
| 1970s-80s (high inflation) | 10-14% |
| 2021-2022 (post-COVID) | 7-9% |
| Fed target | 2% |
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