What Is Inflation, and What Is the Inflation Rate?

Inflation is the increase in prices of goods and services over time. As costs rise, your purchasing power falls — meaning the same amount of money buys less.

Here’s more about inflation, including what you can do to reduce the sting of climbing prices.

What is inflation?

Inflation is a broad measure of how much more expensive consumer goods and services have become over a certain period, often a year.

When everything becomes more expensive, your paycheck doesn’t stretch as far. This can affect everything from your weekly budget to your savings.

Too much inflation can make it harder to save money for retirement goals, emergencies and big purchases.

When inflation is high, the Federal Reserve — the U.S. central bank — typically raises interest rates, which makes borrowing more expensive and slows the economy, reducing inflation. When inflation is too low, the Fed generally drops rates to encourage economic growth and move inflation higher.

While 0% inflation may seem ideal, economists say a little inflation is a good thing. The Fed aims for a 2% annual inflation rate — enough for a healthy, flexible economy that encourages spending but minimizes strain on consumers.

What is the current inflation rate?

The current U.S. inflation rate is 2.9%, according to the Bureau of Labor Statistics.

This represents a significant drop from its peak in June 2022, when the Consumer Price Index (CPI) rose a whopping 9.1% from the year before. Prices have trended downward since that summer high, hitting 6.5% in December 2022 and 3.4% in December 2023.

The CPI is a weighted average of price changes for hundreds of products and services. Prices are always changing, often shifting at different rates and in different directions.

Here are the prices that changed the most over the last year.

Inflation hit these items hard in 2024

What causes inflation?

Inflation has three primary causes, including high demand from consumers and businesses, shortages of goods or services, and expectations that inflation will continue. Here’s more about each one:

1. Demand-pull inflation: If too many consumers want an item in limited supply, that excess demand will push prices upward. Consider the housing market. When mortgage interest rates go down, more people want to buy homes. As the market heats up, prices increase because there are only so many houses to go around.
2. Cost-push inflation: This is kind of what it sounds like. When labor and raw materials begin to cost more, businesses increase prices. An interruption in the lumber supply chain, for example, can mean that lumber prices will rise along with the price of most goods made with lumber.
3. Built-in inflation: At times, inflation can be self-sustaining. If consumers expect that inflation will not slow down, they may demand higher wages to stay afloat — and that raises costs for companies, which may pass those back to consumers.

What are the effects of inflation?

Inflation can benefit some consumers, but many will find themselves feeling pinched. These are a few ways inflation can affect your finances:

• Hurts your purchasing power: Purchasing power is how much you can buy with your money. As purchasing power diminishes, you may feel it in your budget. Monitor your budget closely to make sure you’re living within your means, and, if you can, try to negotiate for a raise to keep up with rising costs.
• Typically hikes your borrowing costs: The cost of borrowing often increases as lenders need to adjust interest rates to compensate for the decline in purchasing power due to inflation.
• Cuts into the value of savings: Whether your savings account balance increases or remains the same, its real value decreases over time if the interest you earn doesn’t keep up with inflation. Your balance may appear to grow, but your money buys less over time. And that can make reaching long-term financial goals difficult.
• Erodes fixed investment returns: Investments such as stocks and precious metals may be able to keep up with inflation better than fixed-return options.

How to protect your finances from inflation

You may not be able to avoid the effects of inflation completely, but you can take some steps to soften the blow.

1. Look closely at your budget. See if you can shift what you’re spending your money on so that inflation has less of an effect on your wallet. Make sure you’ve assessed nonessential and essential expenses.
2. Take stock of your emergency savings. Make sure you can cover three to six months of essential expenses. Know your day-to-day costs, if you don’t already, to confirm you have enough cash on hand. You may need to add to your emergency savings. Consider opening a high-yield savings account to take advantage of rising rates.
3. Make sure your investments are diversified. Spreading risk evenly across your financial portfolio provides some protection against inflation.

How is inflation measured?

There are many different measures of inflation, but the two primary measures of consumer prices are the CPI and the personal consumption expenditures (PCE) price index.

CPI

The CPI, calculated monthly by the Bureau of Labor Statistics, tracks price inflation for a wide variety of goods and services. These include food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and others. After weighing these expenditures based on their relative importance, the CPI illustrates how the cost of living has changed over time.

PCE

The PCE tracks consumer spending, just like the CPI. But unlike the CPI, which only examines urban spending, the PCE covers urban and rural consumers. The PCE also sheds light on how much money consumers are spending versus saving.

PCE is a better measurement tool than CPI because it can adapt to new spending patterns faster, according to the Federal Reserve. PCE inflation increased 2.6% in December 2024 following a 2.4% rise in November.

“Core PCE,” the Fed’s primary inflation measurement, excludes more volatile goods, such as food and energy.