The inflation rate reflects the average annual increase in prices measured across an economy. It is calculated by comparing the current price index for goods and services to the previous year’s price index. A higher inflation rate erodes the purchasing power of money, making it more difficult for individuals to afford the same items and services they could have bought with their money in the past. Inflation rates are often controlled by central banks, which may raise interest rates or constrain the supply of money in an effort to manage inflationary pressures.
High levels of inflation can have negative effects on both consumers and businesses, but the impact varies widely between sectors. Consumers face increased costs, which can lead to household belt-tightening and pessimism about the economy. For businesses, higher prices for raw materials and energy can eat into margins. Inflation can also be disruptive for those on fixed incomes, such as retirees receiving a set pension or those with mortgages tied to the prime rate.
Inflation is a dynamic process that can be driven by many factors, including changes in the supply of goods and services, increases in wages and labor shortages. A spike in prices can be short-lived, as in the case of the COVID-19 pandemic, or it can persist for longer periods as in the case of the Great Depression in the 1930s.
Inflation has slowed since the peak of the 2022 to 2023 COVID-19 pandemic recession, but it remains stubbornly above the Federal Reserve’s target of 2 percent. Investors are paying close attention to signs that implemented and proposed tariff policies could re-ignite inflationary pressures.