Inflation occurs when prices across a sector, such as retail or automotive, rise. This is different from a price spike for a single product or service; it refers to an overall increase in prices, and can be dangerous to economic growth when it gets out of control. When businesses have to pay more for raw materials, they pass that on to consumers by raising their prices. That can lead to higher wages, which in turn leads to more spending on goods and services, driving up aggregate demand again. This cycle is hard to break, but inflation can be kept in check by a central bank that increases the money supply or adjusts interest rates to keep a lid on prices.
Individuals can also influence inflation by choosing to spend their money differently. For example, people may decide to purchase goods and services from local businesses instead of national ones, or they might invest their money to earn an interest rate that exceeds the current inflation rate. The Bureau of Labor Statistics and other agencies produce price indices to help policymakers, business leaders, and consumers track the general direction of prices over time. The CPI is the most well-known of these, and it includes the average increase in prices paid by urban consumers for a basket of items.
The CPI is comprised of several different categories that are weighted based on what percentage of the average consumer’s spending goes to each item. This allows a better picture of price trends to be created; food and energy prices, for instance, are more volatile than other categories, so they’re excluded from headline inflation.
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