If your paycheck doesn’t stretch quite as far as it used to, it’s because prices are rising across a wide range of goods and services. That’s what happens when inflation rises, and the economic principle of supply and demand works its magic.
Inflation is the decrease in purchasing power of a currency, and it’s an important part of any economy. As prices increase, each monetary unit can buy fewer and fewer items, which leads to households tightening their belts and pessimism about the economy. For corporations, they may also see profit margins shrink as production costs rise as a result of inflation.
While the cause of inflation is varied, it’s important to note that inflation always results from a monetary mismatch and has nothing to do with dwindling supplies of oil or wage demands by workers. The speed at which a monetary impulse filters through to prices and wages depends on a host of factors, including people’s expectations of inflation, the degree of slack in the economy, and even the currency’s elasticity.
To get a picture of inflation’s impact on real-world spending, economists and others track price indexes, like those published by the Bureau of Labor Statistics. In particular, the CPI tracks the cost of the basket of goods and services that urban consumers purchase on a regular basis. Another measure, the PCE price index, tracks a broader range of goods and services and includes healthcare costs. Both the CPI and the PCE price index track the prices of both tradable and non-tradable goods. Core inflation, which excludes volatile food and energy prices, is less influenced by short-term supply and demand conditions in individual markets and helps central banks discern the long run impact of their monetary policies.