When it comes to planning for the future, most savings accounts don’t pay enough interest to match or even come close to keeping up with inflation. That’s why it’s important to “bake in” a realistic inflation rate when creating your financial goals.
Inflation is a complicated economic phenomenon that influences many different aspects of our lives. Consumers care about it because it affects how much they have to spend to buy the same things, businesses closely watch it because it impacts the price of raw materials and labor costs, and governments use it to determine tax rates and the interest cost on national debt. A low, steady or predictable level of inflation is often considered good for an economy because it signals growth and healthy demand for goods and services.
The most commonly used metric to measure inflation is the Consumer Price Index (CPI). This includes prices for a broad basket of economic goods and services consumed by households, including food, cars, education, and entertainment. The CPI is weighted by how much people purchase each item, so if one specific product experiences a huge price spike it will affect the overall headline inflation rate. However, policymakers prefer to look at a more detailed measure of inflation, called core consumer inflation, which excludes the price fluctuations of certain items that are most affected by seasonal or temporary supply conditions.
Other important measures of inflation include the Producer Price Index (PPI) and Gross Domestic Product (GDP) deflator. The PPI is similar to the CPI but includes prices at the manufacturing or wholesale stages before reaching the final consumer. GDP deflators are generally more closely tied to the business cycle than the CPI or PPI.