The word inflation was first used in the 19th century to describe several economic phenomena. Economists now agree that sustained inflation occurs when a country’s money supply growth outpaces economic growth. The result is that prices rise, and one unit of currency buys fewer goods and services in aggregate. This decrease in purchasing power is a burden for households that can lead to belt-tightening and pessimism about the economy.
However, price changes can occur for many reasons and aren’t necessarily indicative of inflation. For example, the price of oranges can rise because of a frost in Florida or the cost of parking at a sporting event can increase due to increased demand. While these increases may impact people’s purchasing power, they are not considered to be indicative of inflation since the prices will likely return to their previous levels in the near future.
Every household spends differently, which is why the consumer price index (CPI) was developed by the Bureau of Labor Statistics (BLS). The CPI measures all of the goods and services that an average household needs to live. These include commodities like food grains and metals, utilities like electricity and transportation, and services such as healthcare, entertainment, and labor. Each month, the CPI compares the prices of these products and services to their prices one year ago to find the rate of increase. The monthly increases are then annualized to express the effects of the month-to-month price increases over a year.