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Updated January 5, 2023
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
Headline inflation can provide a more accurate sense of the
value of money.
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 November 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. In reality, this is nearly impossible for two reasons.
First, the quality of goods and services change over time.
Alternative Measures of Inflation
As such, some portion of increasing prices over time is due
Alternative price indices will use different goods within
to improvements in quality rather than inflation. Second,
their market baskets and are generally used for different
new products are introduced into the marketplace over time
purposes. For example, the CPI includes consumer goods
that are fundamentally different than any previously
and services typically purchased by households, which is
available products and are only slowly incorporated into
often used to adjust household incomes for inflation over
price indices with fixed baskets. Statistical agencies try to
time. By contrast, the gross domestic product (GDP)
adjust data to account for these factors, because, if these
deflator, which is generally used to adjust GDP for inflation
complications are not correctly accounted for, measured
over time, measures inflation for all of the final goods and
inflation would be inaccurate and most likely overstated.
services produced in the United States. There are a number
Causes of Inflation
of additional measures of inflation, including the Producer
Price Index, Employment Cost Index, Personal
Inflation is largely the result of two different phenomena,
Consumption Expenditures Index, and Import/Export Price
which are often referred to as demand-pull and cost-push
Index. Different inflation measures are calculated
inflation. Demand-pull inflation occurs when demand for
differently. For example, the CPI uses a (mostly) fixed
goods and services within the economy exceeds the
economy’s capacity to produce goods and services. As
basket of goods and services, whereas the GDP deflator
allows the composition of its market basket to change with
demand exceeds supply within the economy—“too much
money chasing too few goods”—
spending patterns from period to period.
there is upward pressure
placed on prices, resulting in rising inflation.
Additionally, within a specific price index, researchers
often make separate calculations for so-called headline
Cost-push inflation occurs when the price of input goods
inflation and core inflation, as seen in Figure 1. Headline
and services increases. The classic example of cost-push
inflation is the result of an oil shock, which sharply
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Introduction to U.S. Economy: Inflation
decreases the supply of oil and other petroleum products.
actions undertaken by the Federal Reserve as part of its
The decrease in oil supplies increases the price of oil and
mandate to promote stable prices.
petroleum products. Petroleum products are an input good
for a significant portion of goods and services across the
In the time between the financial crisis and the COVID-19
economy, and as the price of this important input good
pandemic, inflation ran below 2% fairly consistently,
increases, so does the price of the final goods and services,
despite an 11-year economic expansion that ended in 2020
resulting in inflation. Cost-push inflation results in only a
and several notable periods of quantitative easing by the
temporary increase in inflation unless accommodated by
Federal Reserve. However, inflation started rising in March
monetary policy.
2021 and has been high since then. In response to this high
inflation, the Federal Reserve has raised the federal funds
Changes in inflation expectations can also cause changes in
rate consistently beginning in March 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.
Ultimately, these inefficient decisions reduce incomes,
To adjust nominal figures for inflation, multiply the
economic growth, and living standards. For this reason, it is
nominal figure by the ratio of the price index value in the
generally accepted that inflation should be kept low to
target year to the price index value in the base year, as
minimize these distortions in the economy. Some would
shown in Figure 2. For example, median household income
argue that an inflation rate of zero is optimal. However, a
in 1990 (the base year) was $29,943 in nominal terms. To
target of zero inflation makes a period of accidental
determine the equivalent income in terms of purchasing
deflation more likely, and deflation is thought to be even
power for 2019 (the target year) using CPI, multiply
more costly than inflation, as it can be associated with
$29,943 by the ratio of CPI in 2019 (256) to the CPI in
recessionary conditions. In an effort to balance these two
1990 (131), which comes out to about $58,515.
risks, policymakers, including the Federal Reserve, often
target a positive but low inflation rate, generally around
As discussed previously, there are a number of different
2%, which reduces inefficiencies within the economy while
price indices, and within those indices more specific
protecting against deflation.
deflators are available to make inflation adjustments. It is
The Federal Reserve and Inflation
important to use the most relevant index for the subject
being researched. For example, when looking at corporate
The Federal Reserve has been charged with promoting
revenues in the United States, it would be advisable to use
stable prices by statute since the late 1970s, largely as a
the Producer Price Index, which uses a market basket
result of the volatile and exceptionally high inflation
consisting of the price of goods and services sold by
experienced in the years preceding the law, as shown in
domestic producers, as opposed to the CPI, which is
Figure 1. Beginning in 2012, the Federal Reserve began
designed to reflect the goods and services purchased by the
explicitly targeting a long-run inflation rate of 2%. In 2020,
typical household.
the Federal Reserve amended this strategy slightly to target
an average rate of 2%. The Federal Reserve generally uses
Resources
its ability to impact short-term interest rates to combat
The Bureau of Labor Statistics and the Bureau of Economic
demand-pull and cost-push inflation in an effort to decrease
Analysis both create various price indices, which are
the volatility of inflation and keep inflation close to its
available at http://www.bls.gov/bls/inflation.htm and
target rate.
https://www.bea.gov/data/prices-inflation, respectively.
Beginning in the 1980s, the rate of core inflation, which
(Note: This In Focus was originally authored by Jeffrey
excludes energy and food prices, started to decrease, as did
Stupak, former CRS Analyst in Macroeconomic Policy.)
the volatility seen in the measure. Beginning in the late
1990s, the inflation rate remained relatively close to 2%,
and large swings in inflation mostly disappeared. The
Lida R. Weinstock, Analyst Macroeconomic Policy
moderation of inflation largely seen between the 1970s and
IF10477
the current high inflation has largely been attributed to the
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Introduction to U.S. Economy: Inflation
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