The rate at which prices increase can influence many facets of an economy, from people’s purchasing power to the price of goods and services. Understanding and managing inflation can be important to a nation’s economic health.
Statistical agencies measure the change in prices of a basket of goods and services, called a price index. They compare the index from one period to another to determine an inflation rate. For example, the Bureau of Labor Statistics’ Consumer Price Index (CPI) measures the change in prices paid by consumers in urban areas and is widely used to determine cost-of-living adjustments for workers and to adjust benefits for Social Security recipients.
Governments and companies may use several measures to track price trends, with most focusing on core inflation, which excludes food and energy prices. These prices tend to be highly volatile and can give a misleading picture of long-term inflation trends, so excluding them helps make the index more useful for policymakers and financial market participants.
One of the biggest risks to an economy is when a higher relative rate of inflation makes imports cheaper than domestic products, which reduces exports and overall economic growth. Countries can also be hurt by high inflation when it makes their currency less valuable, causing them to run a trade deficit and increasing their interest payments on their national debt.
For businesses, rising inflation can cause prices to rise even before they raise them for end customers, because raw materials and production costs will increase too. This is known as cost-push inflation, and it’s a challenge for companies to manage because it puts them at risk of losing profitability.