Price Stability
The third macroeconomic goal is to keep overall prices for goods and services fairly steady. The situation in which the average of all prices of goods and services is rising is called inflation. Inflation’s higher prices reduce purchasing power, the value of what money can buy. Purchasing power depends on two things: inflation and income. If incomes rise at the same rate as inflation, there is no change in purchasing power. If prices go up but income doesn’t rise or rises at a slower rate, a given amount of income buys less, and purchasing power falls. For example, if the price of a basket of groceries rises from $30 to $40 but your salary remains the same, you can buy only 75 percent as many groceries ($30 ÷ $40) for $30. Your purchasing power declines by 25 percent ($10 ÷ $40). If incomes rise at a rate faster than inflation, then purchasing power increases. So you can, in fact, have rising purchasing power even if inflation is increasing. Typically, however, inflation rises faster than incomes, leading to a decrease in purchasing power.
From the early 2000s to April 2017, inflation in the United States was very low, in the 0.1 to 3.8 percent range. For comparison, in 2022, inflation ranged between 6.5 and 9.1 in large part because of supply chain disruptions following COVID-19 pandemic shutdowns.[1] Some nations have had hyperinflation in recent years. In 2018, inflation in Venezuela reached an astounding 65,000%.[2] In South Sudan, inflation peaked at 550% in 2016.
Types of Inflation
There are two types of inflation. Demand-pull inflation occurs when the demand for goods and services is greater than the supply. Consumers have more money to spend than the amount needed to buy goods and services available at that time. Their demand, which exceeds the supply, tends to pull prices up. The higher prices lead to greater supply, eventually creating a balance between demand and supply.
Cost-push inflation is triggered by increases in production costs, such as expenses for materials and wages. These increases push up the prices of final goods and services. Wage increases are a major cause of cost-push inflation, creating a “wage-price spiral.” For example, assume the United Auto Workers union negotiates a three-year labor agreement that raises wages 3 percent per year and increases overtime pay. Carmakers will then raise car prices to cover their higher labor costs. Also, the higher wages will give autoworkers more money to buy goods and services, and this increased demand may pull up other prices. Workers in other industries will demand higher wages to keep up with the increased prices, and the cycle will push prices even higher.
How Inflation Is Measured
The rate of inflation is most commonly measured by looking at changes in the consumer price index (CPI), the prices of a list of goods and services purchased by typical urban consumers. It is published monthly by the Department of Labor. Major components of the CPI, which are weighted by importance, are food and beverages, clothing, transportation, housing, medical care, recreation, and education. There are special indexes for food and energy. The Department of Labor collects about 80,000 retail price quotes and 5,000 housing rent figures to calculate the CPI.
The CPI sets prices in a base period at 100. The base period, which now is 1982–1984, is chosen for its price stability. Current prices are then expressed as a percentage of prices in the base period. A rise in the CPI means prices are increasing. For example, the CPI was 296.2 in August 2022, meaning that prices have almost tripled since the 1982–1984 base period.[3]
Changes in wholesale prices are another important indicator of inflation. The wholesale price is what a business pays for goods that will be resold to a buyer. The producer price index (PPI) measures the prices paid by producers and wholesalers for various commodities, such as raw materials, partially finished goods, and finished products. The PPI, which uses 1982 as its base year, is actually a family of indexes for many different product categories, including crude goods (raw materials), intermediate goods (which become part of finished goods), and finished goods. Because the PPI measures prices paid by producers for raw materials, energy, and other commodities, it may foreshadow subsequent price changes for businesses and consumers. For example, the PPI for finished goods increased by 8.7% from August 2021 to 2022. This may mean that businesses will increase their prices due to higher production costs.[4]
- “Historical Inflation Rates: 1914–2025,” http://www.usinflationcalculator.com, ↵
- Thomas, Jennifer Ann. “Venezuelans Exit Hyperinflation but See Few Reasons to Celebrate.” news.trust.org, August 1, 2022. https://news.trust.org/item/20220729103702-l9o85/. ↵
- BLS.gov. “CONSUMER PRICE INDEX – AUGUST 2022.” Accessed March 26, 2023. https://www.bls.gov/news.release/pdf/cpi.pdf. ↵
- data.bls.gov. “Databases, Tables & Calculators by Subject.” Accessed March 26, 2023. https://data.bls.gov/timeseries/WPUFD4&output_view=pct_12mths. ↵