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Inflation
Definition
Inflation is the rate at which the general level of prices for goods and services rises over time, eroding purchasing power.
Explanation
Inflation is measured by the Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE) index. Moderate inflation of 2-3% is considered healthy for an economy. High inflation erodes savings value and purchasing power, while deflation can indicate economic problems.
Inflation impacts financial planning significantly. A dollar today buys less than a dollar ten years ago. Investment returns must outpace inflation to grow real wealth. Fixed-income retirees are especially vulnerable to inflation risk.
Example
At 3% annual inflation, something that costs $100 today will cost about $134 in 10 years and $181 in 20 years.