An inflation rate measures the average change over time in the prices of a basket of economic goods and services purchased by consumers. It is an important statistic that helps determine the purchasing power of a currency, and is closely watched by policymakers. A high inflation rate can be a sign of a growing economy, but too much can cause problems for businesses and individuals.
Inflation is the increase in the general price level of goods and services, and can affect all aspects of the economy. A rise in the price of commodities, such as food and energy, can be a primary driver of inflation. However, the price of these commodities is largely determined by supply and demand factors in the marketplace. For this reason, these volatile commodity prices are often excluded from core consumer inflation indices like the CPI and PCE, which focus on underlying long-term trends in consumer prices.
The Fed’s 2% target inflation rate encourages price stability, which supports employment and economic growth. High rates of inflation can make it hard for households to afford basic necessities, and may discourage people from borrowing and investing. It also reduces the value of savings, which hurts savers – especially those with fixed incomes like pensioners. It can also affect international trade relations by making exports more expensive and imports cheaper, reducing overall economic growth.
Investors have to keep inflation in mind when planning their portfolios. It can impact the expected return of a bond or stock, and challenge traditional diversification strategies. For example, stocks and nominal bonds typically have a negative reaction to upside surprises in inflation, while commodities and Treasury Inflation-Protected Securities (TIPS) tend to have positive responses.
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