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L.1 · BEGINNER · 2 MIN

Inflation: What It Is and Why It Matters

Inflation is the rate at which the general price level rises over time. The Fed targets roughly 2% annual inflation, a balance between preserving purchasing power and avoiding deflation.

Quiz · 5 questions ↓

The main inflation gauges compared

MeasureWhat It TracksUsed For
CPIConsumer prices (food, housing, transport)Official inflation rate, TIPS adjustment
Core CPICPI minus food and energy (volatile)Public trend gauge; Fed watches Core PCE, not Core CPI
PCEPersonal Consumption ExpendituresFed's primary policy target
PPIProducer/wholesale pricesLeading indicator of consumer inflation

How inflation erodes your purchasing power

Inflation erodes purchasing power. At 3% inflation, $100 today buys only $74 worth of goods in 10 years. This is why cash in a savings account is silently losing value.

Find current inflation data

Check the Markets view for current CPI and inflation data in the macro indicators section.

What the Fed does when inflation runs hot

The Fed targets 2% inflation. If inflation is running at 5%, what is the Fed most likely to do?

Inflation: the invisible tax on your returns

Inflation is the invisible tax on every investor. Understanding it is the first step to making sure your returns are real, not just nominal.

Check your understanding

Sit with the ideas.

A savings account pays 4.5% interest. CPI inflation is running at 3.2%. Core PCE is at 2.8%. What is your approximate real return, and which inflation measure would the Fed focus on?

Why:
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Other lessons in this course.

  1. 01Inflation: What It Is and Why It Matters— reading now
  2. 02The Fed and Interest Rates: How Policy Moves Markets
  3. 03The Yield Curve, in Plain English
  4. 04GDP: What the Economy Actually Produces
  5. 05The Business Cycle: Timing the Economic Seasons
  6. 06Fiscal Policy: Government Spending, Taxes, and Deficits
  7. 07The Fed’s Advanced Toolkit: QE, QT, and Forward Guidance
  8. 08Trade, Exchange Rates, and the Dollar
  9. 09Financial Crises: How Economies Break Down
  10. 10How the Federal Reserve Actually Works
  11. 11How Banks Create Money (and Why Reserves No Longer Bind)
  12. 12Reading a Bank Income Statement
  13. 13Bank Capital, Tier 1 Ratios, and Stress Tests
  14. 14Yield Curve Shape and Bank Net Interest Margin
  15. 15How a Modern Bank Run Unfolds
  16. 16National Income Identities: Why S = I and Y = C + I + G + NX
  17. 17Current Account = Capital Account: Trade Deficits as Inflows
  18. 18Fiscal Multipliers: Why $1 of Spending Isn't $1 of GDP
  19. 19Exchange Rate Regimes and the Impossible Trinity
  20. 20Capital Flows and Sudden Stops: Why EM Crises Look Alike
  21. 21The COT Report: Reading Speculative Positioning
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