What is inflation? Understanding why prices rise, what causes it and who it hurts most.

Inflation is hovering near a 40-year high, driven by steep increases in food prices, housing and utilities.

The Federal Reserve is trying to bring it down by aggressively raising interest rates, even if it pushes the economy closer to a recession.

Still, prices are soaring, making it harder for many Americans to get by.

The Consumer Price Index, or CPI report, published on Tuesday and provided key information on the prices of various consumer goods and services and how much they have risen over the past month and year. The data also gave an idea of whether inflation is beginning to cool.

While it is easy to see and measure those price changes, it is something else to actually understand them.

Inflation can impact many things besides costs, such as employment and wages.

So, what is inflation, and what causes it?

What is inflation?

Inflation is a “generalized rise in prices,” said Josh Bivens, the director of research at the Economic Policy Institute, a left-leaning think tank based in Washington D.C. For example, goods like gas, rent or food can be impacted by inflation.

“Inflation, though, really is meant to only refer to all goods and services, together, rising in price by some common amount,” he explained.

What causes inflation?

Inflation can be caused by several factors. The most common is “a macroeconomic excess of spending over the economy’s relative ability to produce goods and services,” Bivens said.

In this instance, more people are spending money on goods or services that are not readily available to meet those demands, so producers begin to raise prices.

“If everyone in the economy, tomorrow, decided they weren’t going to save any money from their paychecks, and they’re just going to spend every last dollar out of the blue, they would all run to the stores and try to buy things,” Bivens said. “But, producers haven’t produced enough to accommodate that big surge of across-the-board spending. So, you would see prices bid up.”

Another cause of inflation is a lack of producers. If there are not enough workers to produce the demanded good or service, this would lead to an increase in prices as well, Bivens said.

“Labor is the primary component of cost of producing anything,” he explained.

There is also a level of “built-in inflation” within economies, where systems try to get inflation to revolve around a steady percent.

In the U.S., the Federal Reserve System’s target inflation is 2%. This means businesses can increase prices by 2% each year, and the market will still be competitive. Workers can also ask for a 2% wage raise based on these increases, so they can still afford goods and services.

“That 2% is kind of the built-in inflation; what everyone expects to happen,” Bivens said.

What does CPI stand for?

CPI stands for the Consumer Price Index. It is a metric used by the US Bureau of Labor Statistics to gauge how much the price of consumer goods and services has changed over time.

It can effectively measure inflation in an urban market and give government officials and everyday citizens alike an idea of the health of the overall economy.

The most recent CPI report, released on Feb. 14, 2023, indicated that the Consumer Price Index for All Urban Consumers (CPI-U) rose 0.5 percent in January on a seasonally adjusted basis. Over the last year, the all-items index increased 6.4 percent before seasonal adjustment.

The index for ‘shelter,’ meaning the cost of housing, was by far the largest contributor to the CPI increase. That means Americans are paying more on rent and mortgages. Food, gasoline, and natural gas were also contributors.

How is Inflation measured?

In the most basic sense, inflation is measured by comparing the current price of goods and services against their recent history.

This is done by looking at a number of government-released data reports.

The CPI is the most prominent of these metrics. Released by the US Bureau of Labor Statistics, the Consumer Price Index measures the prices of goods in an urban market, which represents over 90% of the American public.

The CPI looks at a ‘fixed basket’ of some 80,000 goods and services to come up with these numbers. What gets put in that basket depends on the Consumer Expenditures Survey which polls Americans to determine which goods are important. The importance of those goods then determines their weight in the CPI– for example, the price of something like gasoline, which forms an integral part of many people’s cost of living, will contribute more than other items.