Inflation raises prices across the economy and reduces the purchasing power of a dollar over time. It can also transfer resources from net nominal savers to net nominal borrowers. For example, if Alice lends Bob $100 at 5 percent interest and prices rise by 10 percent that year, Bob’s repayment will buy less in the way of goods and services than when he borrowed it. For these reasons, inflation is a major concern for economists and policymakers.
In the US, a low, steady, and predictable rate of inflation is considered desirable because it signals healthy economic growth and demand for goods and services that businesses must supply. That, in turn, leads to higher employment and wage growth that consumers can use to purchase goods and services. Then the cycle repeats itself. A high, volatile or unpredictable rate of inflation can lead to serious economic problems.
A common measure of inflation is the Consumer Price Index (CPI). However, CPI includes some government-set prices and items that are more subject to seasonal factors or temporary supply conditions. To get a more meaningful picture of long-term inflation trends, policymakers often focus on measures that exclude those types of products and include more stable components like core consumer inflation.
Another key to understanding inflation rates is that households’ consumption patterns vary considerably. A number of studies, including a 2019 article in the Quarterly Journal of Economics by Xavier Jaravel of the London School of Economics and Political Science, have found that the inflation experiences of households with different income levels can differ substantially from each other. Higher-income households, for example, typically experience lower inflation than those with lower incomes. This could be because innovation and competition in product offerings for those households have kept prices down.