Inflation is a slow but persistent erosion of the purchasing power of the money in your wallet or bank account. It affects everyone, from individual consumers to business owners to those on fixed incomes, and those who are owed money. The Federal Reserve cares about inflation because if it gets out of hand, it can cause a lot of economic harm.
To calculate the inflation rate, statistical agencies start with a market basket of consumer goods and services—often called the Consumer Price Index (CPI). Changes in the prices of this market basket are what drives changes in the CPI. Then they compare the value of the index from one period to another, such as month to month or year to year. This gives a monthly or quarterly rate of inflation.
A rise in the price of a specific good or service, such as an increase in the cost of a new car, is one of the most common causes of inflation. This type of inflation is known as demand-pull inflation, where high demand for a product pushes up its prices and increases the costs for businesses to produce it.
Core consumer inflation, which excludes food and energy prices that are more volatile, is seen as a better indicator of the underlying pace of price changes. But calculating an overall inflation rate, or even an inflation rate for a country, requires a more comprehensive price index, such as the GDP deflator.
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