The inflation rate is all over the news, and investors are keeping a close eye on it. It’s important to understand because inflation impacts many facets of the economy. It influences people’s purchasing power, affects economic growth, and can raise or lower interest rates on the national debt.
The official rate of inflation is calculated by comparing the current price of a “basket” of goods and services that are typically consumed by households to their prices in the past. The basket is determined by statistical offices and similar institutions after extensive consumption surveys of the average household. Once the basket of goods is established, statisticians compare it month to month and year to year to calculate the annual inflation rate.
When the inflation rate is high, money doesn’t buy as much as it used to, which can make consumers feel poorer and discourage them from spending and saving. It also makes it harder for businesses and individuals to plan their budgets because they can’t predict how prices will change from one day to the next.
Inflation can also distort the distribution of wealth in an economy, as it increases the purchasing power for some groups over time while decreasing it for others. For example, a person with a fixed 3 percent increase to their pension would lose purchasing power over time if there was high inflation, but someone who had taken out a mortgage with an adjustable interest rate could benefit from the higher prices because they can afford to pay more each month.
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