The rate at which prices increase can have a major impact on the economy, eroding the purchasing power of money (or the value of goods and services purchased with it) and raising or lowering interest rates. Understanding and properly managing inflation is therefore vital to a sound economy.
A price index, such as the Consumer Price Index from the Bureau of Labor Statistics, can help policymakers, business leaders, and consumers track overall price changes. The underlying purpose of such an index is to measure the changes in the average price for a given basket of products over time.
For instance, the CPI excluding volatile items—which removes prices for fresh food, fuel and energy, as well as clothing and shoes—is designed to exclude temporary increases in costs caused by weather or supply disruptions. This helps provide a better picture of the long-term trends in prices and is closely watched by policymakers.
During the COVID-19 pandemic, shelter costs drove much of the initial price burst, as did increased demand for consumer goods as people emerged from lockdowns with massive pent-up demand and reduced production and shipping capacity nationwide and globally. But as the market continued to adjust, cost-push inflation became more prominent. This type of inflation occurs when demand for finished goods stays flat but the prices of raw materials and wages rise, pushing producers to pass along these increased production costs to end-consumers.
It’s important to note that even a low level of inflation can have serious implications for lower-income households, who spend a larger proportion of their incomes on essentials and can see their purchasing power erode as prices rise. However, the good news is that inflation has slowed since its peak and remains below the Fed’s 2 percent target.