If you’ve been feeling your money isn’t stretching as far as it used to, don’t panic. It’s not your imagination—that’s the natural result of inflation, an economic phenomenon in which the prices of goods and services rise over time. It’s also why it’s important to diversify your investments.
The most well-known measure of inflation is the Consumer Price Index, or CPI, which compares the price of a basket of 8 key goods and services (like bread, meat, milk, and gasoline) in one period to the same items in the previous period. This helps us judge the impact of rising prices on our daily lives and long-term planning. The CPI is calculated monthly by the Bureau of Labor Statistics. The baskets are weighted according to what percentage of a typical household’s spending goes toward each item.
Inflation can have a variety of causes. Some are “cost-push,” such as when bottlenecks in the production process drive up the cost of inputs, or when natural disasters and other world events disrupt supply chains and limit the amount of available goods. Other causes of inflation are “demand-pull,” including when people anticipate higher prices and build those expectations into wage negotiations or contract price adjustments (like automatic rent increases).
Inflation can have both positive and negative effects on an economy. A surge in inflation reduces the purchasing power of money, making it harder to save and invest for the future. In addition, uncertainty about future inflation erodes confidence in the economy and makes it hard for companies to set profit targets or plan for the long-term.
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