How Inflation is Calculated
The Consumer Price Index (CPI) measures the average change in prices paid by consumers for goods and services over time. The annual inflation rate is the percentage change in CPI from one year to the next.
US Historical Inflation Rates
| Decade | Avg Annual Inflation | Notable Events |
|---|---|---|
| 1970s | 7.1% | Oil crisis, stagflation |
| 1980s | 5.1% | Volcker rate hikes tamed inflation |
| 1990s | 3.0% | Stable growth period |
| 2000s | 2.6% | Dot-com, 2008 financial crisis |
| 2010s | 1.8% | Post-recession low inflation |
| 2020–2022 | 5.8% | COVID-19 supply chain disruption |
| 2023–2024 | 3.2% | Rate hike cycle cooling |
How Inflation Affects Your Money
- Savings accounts: If your savings account earns 1% and inflation is 3%, your real purchasing power is shrinking by 2% per year.
- Fixed income / pensions: Those on fixed incomes are hit hardest — the same nominal payment buys less each year.
- Mortgage holders: Inflation actually helps — you repay your loan in "cheaper" future dollars while your home's nominal value tends to rise.
- Investors: Equities historically outpace inflation over long periods; bonds and cash tend to lose real value during high-inflation periods.
- Salary negotiations: A raise below the inflation rate is effectively a pay cut in real terms.
Protecting Against Inflation
- TIPS (Treasury Inflation-Protected Securities) — US government bonds that adjust with CPI
- I-Bonds — US savings bonds with inflation-linked interest rates
- Real estate — property values and rents tend to track inflation over time
- Equities / index funds — companies can raise prices, preserving real earnings
- Commodities — gold and other commodities often rise during inflationary periods
Frequently Asked Questions
What is the difference between inflation and CPI?
CPI (Consumer Price Index) is the measurement tool — it tracks the price of a basket of goods and services. Inflation is the rate of change in CPI over time. So if CPI rises from 100 to 103 in a year, that is 3% inflation.
What is "real" vs "nominal" value?
Nominal value is the face value in current dollars. Real value adjusts for inflation to reflect actual purchasing power. A salary that grows from $50,000 to $52,000 in a year with 3% inflation has grown nominally but lost real purchasing power.
What inflation rate should I use for future projections?
The US Federal Reserve targets 2% annual inflation as its long-run goal. For conservative planning, 2%–3% is commonly used. For more pessimistic scenarios, 3%–5% captures above-average inflation periods. Historical US average since 1913 is approximately 3.2% per year.
Why does the government want some inflation?
Moderate inflation (around 2%) encourages spending and investment — people are motivated to spend or invest money rather than hoard it as it loses value. It also gives central banks room to cut rates during recessions. Zero or negative inflation (deflation) can trigger economic stagnation as consumers delay purchases expecting further price drops.