Quick answer
Inflation is "the increase in the prices of goods and services over time" [1]. In the US, the best-known measure is the Consumer Price Index (CPI) from the Bureau of Labor Statistics, which tracks the average change in prices consumers pay for a representative basket of goods and services [2].
Key points
- Inflation means a dollar buys less over time; it is measured as a percentage change in a price index.
- The CPI tracks a basket of consumer goods and services in eight major groups, weighted by what households actually spend.
- CPI-U covers over 90% of the US population; CPI-W covers about 30%.
- The Federal Reserve's 2% longer-run goal is measured with a different index, the PCE price index.
- Investors look at real returns: what is left after inflation, not the headline number.
#What exactly is inflation?
The Federal Reserve defines inflation simply: "Inflation is the increase in the prices of goods and services over time" [1]. When prices rise on average, each dollar buys a little less. That loss is called a fall in purchasing power — the amount of goods and services a sum of money can buy.
Inflation is about the average level of prices, not any single item. Gasoline can get cheaper in a month when rent rises, and the overall rate can still go up. That is why it is measured with a price index covering many items at once.
#How does the Bureau of Labor Statistics measure the CPI?
The US Bureau of Labor Statistics (BLS) publishes the Consumer Price Index. It describes the CPI as "a measure of the average change over time in the prices paid by consumers for a representative basket of consumer goods and services" [2]. BLS records about 80,000 item prices each month from thousands of retail establishments, through visits, phone calls and website checks [2].
The basket is grouped into eight major categories: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services [2]. Each category is weighted by how much households actually spend on it. BLS gets those weights from the Consumer Expenditure Surveys, in which more than 20,000 consumer units report their spending each quarter in an interview survey and about 12,000 more keep two-week purchase diaries [2].
How a CPI number is built
#What is the difference between CPI-U, CPI-W and core CPI?
| Measure | What it covers | Why people use it |
|---|---|---|
| CPI-U (All Urban Consumers) | Spending of urban consumers — over 90% of the US population | The headline measure most news reports quote |
| CPI-W (Urban Wage Earners and Clerical Workers) | A subset representing about 30% of the US population | Narrower group of working households |
| All items less food and energy ("core") | The CPI without food and energy prices | Food and energy prices are relatively volatile, so some users watch this to see the underlying trend |
| Seasonally adjusted series | The CPI with regular seasonal patterns removed | Makes short-term trends easier to see |
BLS explains that some users focus on the index excluding food and energy because those prices are relatively volatile and they want to see the "core" or underlying rate [2]. Seasonal adjustment removes price effects that recur at about the same time and size every year, such as weather-related swings [2].
#How do you turn index numbers into an inflation rate?
Most CPI series use a reference base where the average for 1982–84 equals 100 [2]. An index level of 250 would mean prices are, on average, 2.5 times their 1982–84 level. The inflation rate is the percent change between two index levels. BLS notes that index-point changes are less useful than percent changes, and gives this example: if the index moves from 110.000 to 128.000, the change is 18.0 ÷ 110.000 × 100 = 16.4% [2].
#What does inflation do to the value of money?
Inflation compounds, just like interest does (see compound interest explained). A steady rate that sounds small adds up over decades. The example uses round hypothetical rates, not a forecast.
Worked example
What $100 buys after years of steady inflation
You keep $100 in cash. Prices rise at a constant hypothetical rate each year. Purchasing power in today's dollars = 100 ÷ (1 + inflation rate)^years.
- At 2% a year, after 10 / 20 / 30 years
- $82.03 / $67.30 / $55.21
- At 3% a year, after 10 / 20 / 30 years
- $74.41 / $55.37 / $41.20
- At 5% a year, after 10 / 20 / 30 years
- $61.39 / $37.69 / $23.14
- A $50 basket after 10 years at 3% (50 × 1.03^10)
- $67.20
At 3% a year, cash loses half its buying power in about 23.4 years (ln 2 ÷ ln 1.03) and keeps $41.20 of value per $100 after 30. The rate looks small; the time does the damage.
Hypothetical constant rates calculated in Python. Real inflation varies from year to year.
Buying power of $100 after 30 years
#Why do investors care about inflation?
Because what matters is what your money can buy, not the number on the statement. The return after inflation is called the real return. If an investment grows 5% in a year while prices rise 3%, $1,000 becomes $1,050, but in today's dollars it is worth about $1,019.42 — a real return of about 1.94%, not 5% (1.05 ÷ 1.03 − 1, calculated in Python).
Inflation also feeds into interest rates. The Federal Reserve's policymakers judge that inflation of 2% over the longer run, measured by the annual change in the price index for personal consumption expenditures (PCE), is most consistent with the Fed's mandate [3]. That is a different index from the CPI; the Fed says it uses PCE because it covers a wide range of household spending, while still tracking the consumer price indexes [1]. How rate decisions reach stock prices is covered in how interest rates affect stocks.
Some US government bonds are designed to adjust for inflation. Our guide to TIPS and I bonds explains how they work.
#What does the CPI not measure?
BLS warns that although the CPI is often called a cost-of-living index, "it differs in important ways from a complete cost-of-living measure" [2]. It excludes income and Social Security taxes, and it does not include investment items such as stocks, bonds, real estate and life insurance, because those relate to savings rather than day-to-day consumption [2]. Your own inflation rate depends on what you buy: a household that drives a lot feels gasoline prices more than one that does not.
Common beginner mistakes
Reading index points as a percentage
A rise of 3 index points is not 3% inflation. Divide the change by the starting level, as BLS does in its example.
Comparing different measures
CPI-U, CPI-W, core CPI and the PCE index give different numbers. Compare like with like, and check whether a figure is seasonally adjusted.
Ignoring inflation in long-term plans
Holding long-term savings only in cash means accepting a steady loss of buying power. Short-term needs are different — see building an emergency fund.
Looking only at nominal returns
A 5% return during 3% inflation is about a 1.94% real gain. Always subtract inflation before judging a result.
What's the bottom line?
Inflation is the steady rise in average prices, and in the US it is most often measured by the CPI, built from about 80,000 monthly prices weighted by real household spending. Read it as a percent change, check which measure and period you are looking at, and judge investment results in real terms. For the next piece of the puzzle, see how interest rates affect stocks.
Frequently asked questions
Is inflation always bad?
Not necessarily. The Federal Reserve aims for inflation of 2% over the longer run, as measured by the PCE index, because low and stable inflation helps households and businesses plan saving, borrowing and investment.
How often is the CPI published?
The CPI is a monthly measure: BLS collects prices every month and publishes the results on bls.gov/cpi. Check the release date on the page before using any figure.
What is the difference between inflation and the cost of living?
Inflation measures average price changes for a fixed type of basket. The cost of living includes more, such as taxes and changes in quality of life, which is why BLS says the CPI is not a complete cost-of-living measure.
Why does my personal inflation feel higher than the CPI?
The CPI is an average weighted by typical spending. If you spend more than average on items whose prices rose fastest, your own experience will differ.
Sources
Grade A = primary source (regulator, government agency, official rulebook or the index provider's own documents). Numbers in brackets in the text point here.
- Board of Governors of the Federal Reserve System. What is inflation and how does the Federal Reserve evaluate changes in the rate of inflation? (2026). Accessed 2026-10-03.A
- U.S. Bureau of Labor Statistics. Consumer Price Index: Questions and Answers (2026). Accessed 2026-10-03.A
- Board of Governors of the Federal Reserve System. Why does the Federal Reserve aim for inflation of 2 percent over the longer run? (2026). Accessed 2026-10-03.A
This page is general education, not personal financial, tax or legal advice. Figures in worked examples are hypothetical and calculated before taxes and fees unless stated. Rules and limits change; check the linked primary sources for the current version. How we check every page.
