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Updated November 22, 2022
Introduction to U.S. Economy: Inflation
What Is Inflation?
inflation includes the full set of goods and services within
Inflation is defined as a general increase in the price of
the basket of goods, whereas core inflation excludes energy
goods and services across the economy, or, in other words,
and food prices from the basket of goods. Core inflation is
a general decrease in the value of money. Conversely,
often used by researchers in place of headline inflation due
deflation is a general decrease in the price of goods and
to the volatile nature of the price of food and energy.
services across the economy, or a general increase in the
However, headline inflation can provide a more accurate
value of money.
sense of the price changes actually faced by individuals.
As inflation occurs, individuals can purchase fewer goods
Figure 1 Annual Inflation Rate
and services with the same amount of money. For this
January 1960 to September 2022
reason, an individual would need about $326 in 2021 to
purchase the same amount of goods and services as $100
would have purchased in 1980. Measures of inflation are
used to adjust money figures to keep purchasing power
constant over time, allowing for more accurate comparisons
across disparate time periods. Monetary figures that have
been adjusted for inflation are referred to as real, and non-
inflation-adjusted figures are referred to as nominal.
Measuring Inflation
The rate of inflation can be measured by observing changes
in the average price of a consistent set of goods and
services, often referred to as a market basket. Inflation is
generally measured using a price index, such as the
Source: Bureau of Economic Analysis.
Consumer Price Index (CPI). A price index is constructed
Notes: Annual percentage change as measured by Personal
by dividing the price of a market basket in a given year by
Consumption Expenditures Index.
the price of the same basket of goods in a base year. The
rate of inflation is then measured by calculating the
Complications in Measuring Inflation
percentage change in the price index across different
periods. For example, the CPI was about 277 in October
The fundamental concept behind inflation is to measure
2021 and about 298 in October 2022, which amounts to an
changes in the price of the same goods and services over
inflation rate of about 7.8% over this 12-month period.
time. However, in reality, this is nearly impossible for two
reasons. First, the quality of goods and services change over
Alternative Measures of Inflation
time. As such, some portion of increasing prices over time
Alternative price indices will use different goods within
is due to improvements in quality rather than inflation.
their market baskets and are generally used for different
Second, new products are introduced into the marketplace
purposes. For example, the CPI includes consumer goods
over time that are fundamentally different than any
and services typically purchased by households, which is
previously available products and are only slowly
often used to adjust household incomes for inflation over
incorporated into price indices with fixed baskets.
time. By contrast, the gross domestic product (GDP)
Statistical agencies try to adjust data to account for these
deflator, which is generally used to adjust GDP for inflation
factors, because, if these complications are not correctly
over time, measures inflation for all of the final goods and
accounted for, measured inflation would be inaccurate and
services produced in the United States. There are a number
most likely overstated.
of additional measures of inflation, including the Producer
Causes of Inflation
Price Index, Employment Cost Index, Personal
Consumption Expenditures Index, and Import/Export Price
Inflation is largely the result of two different phenomena,
Index. Different inflation measures are calculated
which are often referred to as demand-pull and cost-push
differently. For example, the CPI uses a (mostly) fixed
inflation. Demand-pull inflation occurs when demand for
basket of goods and services, whereas the GDP deflator
goods and services within the economy exceeds the
economy’s capacity to produce goods and services. As
allows the composition of its market basket to change with
spending patterns from period to period.
demand exceeds supply within the economy—“too much
money chasing too few goods”—there is upward pressure
Additionally, within a specific price index, researchers
placed on prices, resulting in rising inflation.
often make separate calculations for so-called headline
inflation and core inflation, as seen in Figure 1. Headline
Cost-push inflation occurs when the price of input goods
and services increases. The classic example of cost-push
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Introduction to U.S. Economy: Inflation
inflation is the result of an oil shock, which sharply
disappear. The moderation of inflation largely seen between
decreases the supply of oil and other petroleum products.
the 1970s and the current high inflation has largely been
The decrease in oil supplies increases the price of oil and
attributed to the actions undertaken by the Federal Reserve
petroleum products. Petroleum products are an input good
as part of its mandate to promote stable prices.
for a significant portion of goods and services across the
economy, and as the price of this important input good
Until 2021, inflation ran below 2% fairly consistently since
increases, so does the price of the final goods and services,
the financial crisis, despite several notable periods of
resulting in inflation. Cost-push inflation results in only a
quantitative easing and an 11-year expansion that ended in
temporary increase in inflation unless accommodated by
2020. However, inflation started rising in March 2021 and
monetary policy.
has been high since then. In response to this high inflation,
the Federal Reserve has raised the federal funds rate
Changes in inflation expectations can also cause changes in
consistently beginning in March of 2022, tapered asset
actual inflation. Individuals form expectations around the
purchases, and begun shrinking the balance sheet. The Fed
future rate of inflation and incorporate those expectations
has indicated that it will continue tightening monetary
when setting prices at the firm level or when bargaining for
policy until inflation comes down. For more information
wages as a worker. For example, if the general consensus is
about inflation since COVID-19, see CRS Report R47273,
that prices will increase 2% in the next year, businesses will
Inflation in the U.S. Economy: Causes and Policy Options,
want to increase prices by at least 2%, and workers will
by Marc Labonte and Lida R. Weinstock.
want at least a 2% raise.
Adjusting for Inflation
Inflation’s Impact on the Economy
Comparing figures in real terms is often beneficial to
Inflation tends to interfere with pricing mechanisms in the
observe actual changes in purchasing power over time
economy, resulting in individuals and businesses making
rather than changes in the number of dollars.
less than optimal spending, saving, and investment
decisions. Additionally, in the presence of inflation,
Figure 2. How to Adjust for Inflation
economic actors often engage in actions to protect
themselves from the negative impacts of inflation, diverting
resources from other more productive activities.
Source: CRS.
To adjust nominal figures for inflation, multiply the
Ultimately, these inefficient decisions reduce incomes,
nominal figure by the ratio of the price index value in the
economic growth, and living standards. For this reason, it is
target year to the price index value in the base year, as
generally accepted that inflation should be kept low to
shown in Figure 2. For example, median household income
minimize these distortions in the economy. Some would
in 1990 (the base year) was $29,943 in nominal terms. To
argue that an inflation rate of zero is optimal. However, a
determine the equivalent income in terms of purchasing
target of zero inflation makes a period of accidental
power for 2019 (the target year) using CPI, multiply
deflation more likely, and deflation is thought to be even
$29,943 by the ratio of CPI in 2019 (256) to the CPI in
more costly than inflation, as it can be associated with
1990 (131), which comes out to about $58,515.
recessionary conditions. In an effort to balance these two
risks, policymakers, including the Federal Reserve, often
As discussed previously, there are a number of different
target a positive but low inflation rate, generally around
price indices, and within those indices more specific
2%, which reduces inefficiencies within the economy while
deflators are available to make inflation adjustments. It is
protecting against deflation.
important to use the most relevant index for the subject
The Federal Reserve and Inflation
being researched. For example, when looking at corporate
revenues in the United States, it would be advisable to use
The Federal Reserve has been charged with promoting
the Producer Price Index, which uses a market basket
stable prices by statute since the late 1970s, largely as a
consisting of the price of goods and services sold by
result of the volatile and exceptionally high inflation
domestic producers, as opposed to the CPI, which is
experienced during the 1970s, as shown in Figure 1.
designed to reflect the goods and services purchased by the
Beginning in 2012, the Federal Reserve began explicitly
typical household.
targeting a long-run inflation rate of 2%. In 2020, the
Federal Reserve amended this strategy slightly to target an
Resources
average rate of 2%. The Federal Reserve generally uses its
The Bureau of Labor Statistics and the Bureau of Economic
ability to impact short-term interest rates to combat
Analysis both create various price indices, which are
demand-pull and cost-push inflation in an effort to decrease
available at http://www.bls.gov/bls/inflation.htm and
the volatility of inflation and keep inflation close to its
https://www.bea.gov/data/prices-inflation, respectively.
target rate.
(Note: This In Focus was originally authored by Jeffrey
As shown in Figure 1, beginning in the 1980s, the rate of
Stupak, former CRS Analyst in Macroeconomic Policy.)
core inflation, which excludes energy and food prices,
begins to decrease, as does the volatility seen in the
measure. Beginning in the late 1990s, the inflation rate
Lida R. Weinstock, Analyst Macroeconomic Policy
remains relatively close to 2%, and the large swings in
IF10477
inflation, such as those seen during the 1970s, mostly
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Introduction to U.S. Economy: Inflation
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