The annual inflation rate remained 2.7% in July, according to the U.S. Bureau of Labor Statistics. Inflation accelerated for used cars and trucks, transportation services, and groceries, while prices fell for books and childcare.
Most people have felt the effects of inflation in their daily lives, and business leaders have had to grapple with it too, often trying to protect margins while raising prices for consumers. It is vital for everyone to understand how inflation affects their spending and savings decisions, and what the various metrics mean.
Inflation reflects the drop in the purchasing power of money when central banks create more money than people want to hold. This can cause prices and wages to rise, sometimes rapidly. The most common measure of inflation is the Consumer Price Index (CPI), which tracks changes in a basket of goods and services that people use, like bread, books, and shelter. The BLS also publishes a less well-known measure, the Personal Consumption Expenditures Price Index (PCEPI), which uses a different set of goods and services to calculate inflation.
These various measures have their strengths and weaknesses, but they are all important to keep in mind. Ultimately, relative-price changes transmit valuable information about the world and help inform consumption, production, and investment decisions. Inflation can distort these signals, leading people to make unsound choices and slow down economic growth. For investors, a high rate of inflation can lower the returns they receive on saving money in banks and can also reduce the potential return on investing their savings, which is why it is important to bake in expected rates of inflation when creating a plan for reaching financial goals.