Inflation measures how much prices increase over time. When inflation is 3%, something that cost $100 last year costs $103 this year. The U.S. Federal Reserve targets 2% annual inflation.
How Inflation Is Measured
The Consumer Price Index (CPI) tracks prices of a basket of goods and services. The Personal Consumption Expenditures (PCE) index is the Fed's preferred measure.
Impact on Your Money
Inflation erodes purchasing power. $100 today buys less than $100 ten years ago. To maintain value, your investments must grow faster than inflation. At 3% inflation, your money loses half its purchasing power in about 24 years.
Historical Context
U.S. inflation has ranged from near-zero to over 13% (1980) and briefly above 9% in 2022. The Fed's 2% target isn't a hard rule — it's a policy goal balanced against employment. Hyperinflation (loss of currency value at rates of 50%+ per month) is rare in stable economies but has occurred in countries like Zimbabwe and Venezuela when governments print money to cover deficits.
Assets That Historically Outpace Inflation
Stocks, real estate, and Treasury Inflation-Protected Securities (TIPS) have historically kept pace with or exceeded long-run inflation, while cash and low-yield savings accounts typically lose purchasing power over time. This is the core argument for investing rather than only saving for long-term goals.