What Is Inflation? Causes, How It's Measured and How to Protect Your Money From Rising Prices

Your grocery bill crept up again. The same takeout order costs noticeably more than it did last year. Your favorite snack somehow got smaller but not cheaper. And your paycheck feels smaller even though the number on it hasn't changed.

That's inflation. It's one of the most talked-about money topics of the past few years, and it's far less mysterious than the news makes it sound. Understanding it helps you make smarter choices about saving, spending, borrowing and asking for a raise. Here's everything you need to know in plain English.

What is inflation?

Inflation is the general rise in prices across the economy over time. When prices go up, each dollar buys a little less. Economists call that a drop in purchasing power.

If inflation is 3% for a year, something that cost $100 at the start of the year costs about $103 at the end. Your $100 now buys about what $97 bought a year earlier.

A single item getting more expensive isn't inflation by itself. Inflation is when prices rise broadly across many goods and services.

How is inflation measured?

The Consumer Price Index (CPI)

In the US, the most commonly quoted measure is the Consumer Price Index (CPI), published monthly by the Bureau of Labor Statistics. It tracks the prices of a large "basket" of goods and services that households buy, including food, housing, energy, transportation, medical care, clothing, education and entertainment.

When you hear "inflation was 3%," it usually means the CPI was 3% higher than a year earlier.

Core inflation

Core inflation leaves out food and energy prices, which tend to swing up and down a lot. Economists watch it to see the underlying trend.

PCE

The Federal Reserve's preferred measure is the Personal Consumption Expenditures (PCE) price index, which covers a broader range of spending.

Your personal inflation rate

Your personal inflation rate can be higher or lower than the headline number, depending on what you buy. If your rent jumped 10% or you drive a lot when gas prices spike, it may feel much worse than the official figure.

What causes inflation?

There's no single cause, but common drivers include:

• Demand-pull inflation: lots of people want to buy, and businesses can't keep up, so prices rise
• Cost-push inflation: higher costs for wages, energy, materials or shipping get passed on to customers
• Supply shocks: disruptions like bad harvests, wars, pandemics or shipping problems
• Expectations: if people expect prices to rise, they may buy sooner and businesses may raise prices, which can become self-fulfilling
• Money supply: when lots of money flows into the economy quickly, it can push prices up

Recent inflation in the US

After years of low inflation, US inflation surged after the pandemic, peaking at about 9.1% in June 2022, the highest in roughly four decades, driven by supply chain disruptions, strong demand and energy prices. It has since come down, but prices didn't go back to where they were. Lower inflation means prices are rising more slowly, not falling.

Why does the Federal Reserve aim for 2% inflation?

The Federal Reserve aims for inflation of about 2% a year over time. Steady, low inflation is considered healthy for the economy: it encourages spending and investment and gives some room to cut interest rates in downturns.

Deflation, when prices fall broadly, can cause problems too, as people delay buying and businesses cut back and lay people off.

To fight high inflation, the Fed raises interest rates, which makes borrowing more expensive and cools spending. That's why mortgage, car loan and credit card rates tend to rise when inflation is high.

What is shrinkflation?

Shrinkflation is when products get smaller while prices stay the same or rise: fewer chips in the bag, a smaller candy bar, less toilet paper per roll. It's a hidden form of price increase. Check the unit price on shelf labels (price per ounce or per count) to compare fairly.

Inflation vs. recession vs. stagflation

• Inflation: prices rising broadly.
• Recession: a significant, widespread decline in economic activity, often with rising unemployment.
• Stagflation: the unpleasant combination of high inflation and a stagnant or shrinking economy with high unemployment. The US experienced it in the 1970s.

A brief history of US inflation

Inflation has risen and fallen many times. In the late 1970s and early 1980s, US inflation topped 13%. The Federal Reserve, under chairman Paul Volcker, raised interest rates dramatically, pushing mortgage rates above 18% and causing a painful recession, but inflation came down. From the 1990s to 2020, inflation was mostly low and steady, which is why the post-pandemic spike surprised so many people.

How inflation affects your money

Savings

Inflation quietly eats away at cash that isn't earning anything. Using the rule of 72: at 3% inflation, prices roughly double in about 24 years. That's why an emergency fund in a high-yield savings account is better than one in a checking account earning nothing.

Investments

Long-term savings for goals decades away are often invested rather than kept in cash, since stocks have historically outpaced inflation over long periods (with plenty of ups and downs along the way).

Debt

People with fixed-rate debt, like a fixed mortgage, effectively repay with dollars worth a bit less over time. Variable-rate debt, like credit cards and some loans, usually gets more expensive as rates rise.

Wages

If your pay rises more slowly than prices, your real income falls. That's when it's worth asking for a raise.

Retirees

People on fixed incomes are especially affected. Social Security benefits get a cost-of-living adjustment (COLA) each year based on inflation, but many pensions don't.

How to protect your budget from inflation

• Track your spending for a month to see which costs went up most.
• Revisit your budget. The 50/30/20 rule is a good starting framework.
• Shop around for insurance, phone and internet plans once a year. Loyalty rarely pays.
• Cut food waste. Throwing out less food is like getting a raise at the grocery store. See how to reduce food waste.
• Buy store brands for staples. They're often made in similar ways for much less.
• Compare unit prices to spot shrinkflation.
• Plan meals and cook more at home.
• Buy in bulk only for things you'll use before they spoil.
• Cut energy costs by sealing drafts, using LED bulbs and washing clothes in cold water.
• Cancel unused subscriptions.
• Ask about a raise or cost-of-living adjustment at work, with a clear case for your value.
• Pay down variable-rate debt, since interest rates often rise when inflation is high.
• Keep savings in high-yield accounts that earn closer to the inflation rate.

Inflation-protected investments

Some savings options are designed to keep up with inflation:

• Series I savings bonds: US government bonds whose rate adjusts with inflation, bought at TreasuryDirect.gov, with purchase limits
• TIPS (Treasury Inflation-Protected Securities): government bonds whose principal adjusts with inflation

These are general examples, not recommendations. Consider talking with a fee-only financial planner about your situation.

Inflation and your mental health

Rising prices are stressful, especially when wages don't keep up. If money worries are affecting your sleep or mood, you're not alone. Focusing on what you can control, like your budget, spending habits and savings, can help you feel more in charge. Our guide to what stress does to your body has more ideas.

Frequently asked questions about inflation

Will prices ever go back down?

Prices for some items, like gas or eggs, can fall. But overall price levels rarely drop back. The goal is for prices to rise slowly and for wages to keep up.

Do wages keep up with inflation?

Sometimes they do, and sometimes they don't. When wages grow faster than prices, real wages rise. During the inflation spike of 2021 and 2022, prices outpaced wages for many workers, which is one reason it felt so painful.

How can I calculate my personal inflation rate?

Compare what you spent on your regular expenses this year with the same expenses a year ago. The percentage change is roughly your personal inflation rate.

Does inflation affect everyone equally?

No. Lower-income households often feel inflation more, because a bigger share of their budget goes to essentials like food, rent and energy, which can rise quickly.

Is it better to buy now before prices rise?

Only for things you genuinely need and were going to buy soon anyway. Rushing to buy out of fear can lead to overspending and debt.

Is inflation good or bad?

A little is normal and healthy. High inflation hurts, especially for savers and people on fixed incomes.

How does inflation affect interest rates?

When inflation is high, the Federal Reserve often raises interest rates to slow the economy, which affects mortgages, loans, credit cards and savings rates.

Prices may be rising, but this costs nothing: our free wellness wheel quiz.