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Markets & EconomyGlossary

Inflation

Inflation is a general rise in prices that reduces what money can buy. Plain-English definition, how the U.S. measures it, and a worked example.

Also called: rising prices, price inflation

By The Token Thesis Desk2 min read5 cited sources

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Quick answer

Inflation is a general rise in the prices of goods and services over time. As prices rise, each dollar buys less, so inflation reduces the purchasing power of money. In the U.S. it is usually measured by the Consumer Price Index or the PCE price index.

What does inflation mean?#

Investor.gov defines inflation as a general upward movement of prices and notes that it reduces purchasing power, which is a risk for investors receiving a fixed rate of interest[1]. Purchasing power is how much a sum of money can buy. If prices rise and your income or savings do not, you can afford less.

Inflation is measured with price indexes. The Bureau of Labor Statistics' Consumer Price Index (CPI) measures the average change over time in prices paid by urban consumers for a basket of goods and services[2]. The Federal Reserve's 2 percent goal uses a different index, the PCE price index[3]. Our note on how inflation is measured explains both.

What does inflation do to $1,000?#

Worked example

A steady 3.4% a year for five years

The CPI rose 3.4% over the 12 months to August 2026. If prices kept rising at that rate (an illustrative assumption, not a forecast), a basket costing $200 today would cost $206.80 in one year and $236.39 in five years. Put the other way, after one year $1,000 of cash would buy only what about $967 buys today, and after five years only what about $846 buys today.

AfterCost of a $200 basketBuying power of $1,000
1 year$206.80$967.12
5 years$236.39$846.05

Figures computed in code from the stated inputs; rounded to the nearest cent or tenth.

The 3.4% figure is the 12-month change in the CPI for All Urban Consumers reported by BLS for August 2026[4]; the arithmetic is done in code. Actual inflation changes from year to year.

Why does inflation matter for investors?#

An investment only grows your buying power if it earns more than inflation after fees. The rate after subtracting inflation is called the real rate; the Federal Reserve's education site puts it simply: the real interest rate equals the nominal rate minus the inflation rate[5]. Our guide to how inflation affects your money walks through this, and the real return calculator does the math. Central banks also respond to inflation: see how the Federal Reserve sets interest rates.

Sources

Numbers in brackets in the text point here. Grade A = primary source (regulator, statistics agency, law or official document).

  1. 1
    What is Risk?U.S. SEC — Investor.gov (n.d.) · Grade A
  2. 2
    Consumer Price Index (CPI) — overviewU.S. Bureau of Labor Statistics (n.d.) · Grade A
  3. 3
    Monetary Policy: What Are Its Goals? How Does It Work?Board of Governors of the Federal Reserve System (n.d.) · Grade A
  4. 4
    Consumer Price Index — August 2026 (news release, 11 Sep 2026)U.S. Bureau of Labor Statistics (2026) · Grade A
  5. 5
    Getting Real about Interest Rates (Economic Lowdown podcast)Federal Reserve Education (Federal Reserve System) (n.d.) · Grade A

How we checked this note

Every number, date and rule above links to its source. This note cites 5 sources, 5 of them primary (Grade A). Worked examples were calculated in code, and a second editor compared each figure with its source before publishing. Spotted an error? Tell us — corrections are listed on the note. Read our editorial policy.