What the Current Inflation Rate Means for You
The current inflation rate tells you how quickly prices for the stuff you buy is rising (or falling). The Federal Reserve works to keep inflation in a healthy range, but it takes time for the tools to work. By watching the inflation rate, you can make some guesses about what the Federal Reserve might do to influence interest rates, up or down. Inflation influences how consumers spend money now, and their expectations about how they’ll spend in the future.
What Is the Inflation Target?
The core inflation rate excludes the impact of volatile oil and food prices and is often tracked on a year-over-year basis. Core inflation is what the Federal Reserve is talking about when it says its target for inflation is 2%. That’s the rate the bank says is needed to maintain a healthy economy. When inflation is in that healthy range (and is expected to remain there) interest rates throughout the economy are likely to also remain low enough to sustain economic growth, but not so low that the central bank can’t reduce interest rates in the event of an economic slow down or recession. The inflation rate hovered just below the healthy range for quite some time, but in early 2022 it was rising fast enough to cause some businesses and investors to worry.
Deflation
Falling prices warn of deflation. Falling prices may seem like a great thing for shoppers, but deflation often signals an impending recession. With a recession come declining wages, job losses, and big hits to many investment portfolios. As a recession worsens, so does deflation. Businesses lower their prices in an attempt to get consumers to buy their products and services. Deflation is worse than inflation, because it signals falling demand. The Federal Reserve combats deflation with expansionary monetary policy. It reduces the federal funds rate range to influence consumers to spend and banks to loan.
Healthy Inflation
Moderate inflation of around 2% is actually good for economic growth. Consumers are more likely to buy now rather than wait when they expect prices to rise. This spurs demand, driving prices higher. Inflation is a self-fulfilling prophecy. The Federal Reserve monitors the core inflation rate (all goods less food and energy) when it decides whether to raise the fed funds rate range. The Fed uses expansionary monetary policy by lowering its administered rates when the rate is lower than the 2% target. It lowers the fed funds rate range to boost economic growth to prevent or end a recession. The Fed uses contractionary monetary policy when it considers inflation to be rising too quickly. It raises rates to keep prices from rising more rapidly than your paycheck. Higher interest rates weaken consumer demand by making loans more expensive. That slows growth, reducing the economy’s ability to create jobs.
Hyperinflation
People sometimes worry that inflation will skyrocket, causing hyperinflation. They’re concerned that price increases could be like those seen during the Weimar Republic in Germany. Hyperinflation is very rare because it means that prices are rising by 50% per month.
BLS Inflation Calculator
The BLS inflation calculator shows how inflation eats away at your purchasing power. A 2.5% inflation rate means that something that cost $100 last year would cost $102.50 this year. It also means that you’d need a 2.5% raise just to stay even. A hard-earned 3.5% raise would only be worth 1.0% in additional buying power in this situation.
