Inflation is the sustained increase in the general price level of goods and services over time, resulting in a decline of purchasing power. Most major central banks target 2% annual inflation as the optimal balance between price stability and economic growth.
Types of Inflation
- Demand-pull: Too much money chasing too few goods (e.g., post-COVID stimulus boom)
- Cost-push: Rising production costs passed to consumers (e.g., 1970s oil shocks)
- Wage-price spiral: Workers demand higher wages β businesses raise prices β workers demand even higher wages
- Shrinkflation: Same price but smaller quantities β a hidden form of inflation
How It's Measured
In the U.S., the primary measures are CPI (BLS), PCE Price Index (BEA), and the GDP deflator. Core measures (excluding food and energy) are preferred by policymakers for trend analysis. Global comparisons often use the IMF's World Economic Outlook data.
Historical Episodes
- Great Inflation (1965-1982): U.S. CPI peaked at 14.8% in March 1980, driven by oil shocks, Vietnam War spending, and loose monetary policy. Volcker's drastic rate hikes to 20% broke the back of inflation at the cost of a severe recession
- Great Moderation (1984-2019): Inflation averaged 2.5%, with central bank credibility keeping expectations anchored
- Post-COVID Surge (2021-2023): U.S. CPI hit 9.1% in June 2022, driven by supply chain disruptions, fiscal stimulus ($5.2T), and energy price spikes. The 'transitory vs. persistent' debate defined the era
Why 2%?
The 2% target was first adopted by New Zealand's central bank in 1990 and has since become the global standard. It provides a buffer against deflation while minimizing purchasing power erosion. The Fed formally adopted it in January 2012.