Inflation
MacroDefinition
Inflation is the rate at which the general price level rises, eroding the purchasing power of money. If inflation is 3%, something that costs $100 today will cost $103 next year - your dollars buy less over time.
The Federal Reserve targets 2% annual inflation as the sweet spot. Below 2% risks deflation (falling prices, economic stagnation). Above 4% means the economy is overheating. Above 8% is a crisis that forces aggressive rate hikes.
Inflation is measured by the Consumer Price Index (CPI), which tracks price changes across a basket of goods and services (food, housing, energy, healthcare, etc.). "Core CPI" excludes food and energy because they're volatile.
Why it matters for investors: Your investments must earn MORE than inflation to grow real purchasing power. If your portfolio returns 7% but inflation is 4%, your real return is only 3%. This is why keeping all your money in a savings account is actually losing value in most environments - the interest rarely beats inflation.
The Federal Reserve targets 2% annual inflation as the sweet spot. Below 2% risks deflation (falling prices, economic stagnation). Above 4% means the economy is overheating. Above 8% is a crisis that forces aggressive rate hikes.
Inflation is measured by the Consumer Price Index (CPI), which tracks price changes across a basket of goods and services (food, housing, energy, healthcare, etc.). "Core CPI" excludes food and energy because they're volatile.
Why it matters for investors: Your investments must earn MORE than inflation to grow real purchasing power. If your portfolio returns 7% but inflation is 4%, your real return is only 3%. This is why keeping all your money in a savings account is actually losing value in most environments - the interest rarely beats inflation.
How it works
Target
~2%
Goldilocks
Elevated
3-4%
Watch closely
High
5-7%
Fed hikes
Crisis
8%+
Emergency
Formula
Real return = Nominal return − Inflation rate
Example
In 2022, US inflation hit 9.1% - the highest since 1981. A savings account paying 0.5% lost 8.6% in real purchasing power. Even the stock market's -19% return was partially an inflation story - the Fed raised rates aggressively to fight it, crushing asset prices.