What Inflation Is
Inflation is a general rise in prices across an economy, which is the same thing as a fall in the purchasing power of money. A dollar does not change; what changes is how much it buys. The rate is normally measured by tracking the cost of a fixed basket of goods and services over time.
In the United States that measure is the Consumer Price Index (CPI), published monthly by the Bureau of Labor Statistics. The index is set to 100 for the 1982–1984 average, so a reading of 320 means prices are 3.2 times what they were then.
The Formula
Value in year B = Amount × CPI(B) ÷ CPI(A)
To find the average annual rate between two years, take the ratio of the indexes and annualise it:
Average rate = (CPI(B) ÷ CPI(A))1/n − 1
Note that this is a geometric mean, not an arithmetic one. Averaging the individual yearly rates gives a slightly different — and incorrect — answer, because inflation compounds.
What $100 From Each Decade Is Worth Today
| Year | CPI | Equivalent to $100 in that year |
|---|---|---|
| 1920 | 20.0 | $1,610.66 |
| 1930 | 16.7 | $1,928.93 |
| 1940 | 14.0 | $2,300.94 |
| 1950 | 24.1 | $1,336.65 |
| 1960 | 29.6 | $1,088.28 |
| 1970 | 38.8 | $830.24 |
| 1980 | 82.4 | $390.94 |
| 1990 | 130.7 | $246.47 |
| 2000 | 172.2 | $187.07 |
| 2010 | 218.1 | $147.73 |
| 2020 | 258.8 | $124.47 |
The pattern to notice is the long flat stretch before 1940 and the steep climb afterwards. Prices in 1930 were roughly what they had been in 1915; the sustained inflation most people treat as normal is a post-war phenomenon.
Average Inflation by Decade
| Decade | Average annual inflation |
|---|---|
| 1920s | -1.79% |
| 1930s | -1.75% |
| 1940s | 5.58% |
| 1950s | 2.08% |
| 1960s | 2.74% |
| 1970s | 7.82% |
| 1980s | 4.72% |
| 1990s | 2.80% |
| 2000s | 2.39% |
| 2010s | 1.73% |
| 2020s | 4.47% |
The 1930s were deflationary — prices actually fell during the Depression, which sounds pleasant and was not: falling prices raised the real burden of debt and encouraged consumers to postpone spending, deepening the downturn. The 1970s stand out at the other extreme, driven by oil shocks and accommodative monetary policy, and were ended only by interest rates above 15%.
What Causes Inflation
- Demand-pull — demand outruns the economy's capacity to supply, and prices rise to ration what exists.
- Cost-push — input costs rise, most commonly energy or wages, and producers pass them on.
- Monetary expansion — the money supply grows faster than output, so more currency chases the same goods.
- Expectations — if people expect prices to rise, they demand higher wages and set higher prices, which makes the expectation self-fulfilling. This is why central banks care so much about "anchoring" expectations.
- Supply shocks — disruption to production or logistics, as in 2021–2022.
Why Central Banks Target 2%
Most developed-economy central banks aim for around 2% rather than zero. A small positive rate gives room to cut real interest rates below zero during a downturn, allows relative wages to adjust without anyone taking a nominal pay cut, and keeps a safe distance from deflation, which is considerably harder to escape than mild inflation.
Who Inflation Helps and Hurts
| Hurt by inflation | Helped by inflation |
|---|---|
| Savers holding cash | Borrowers with fixed-rate debt |
| Holders of fixed-rate bonds | Owners of real assets — property, commodities |
| Workers on fixed contracts | Governments with large nominal debts |
| Retirees on non-indexed pensions | Businesses that can raise prices quickly |
The mechanism is the same in every row: inflation transfers value from those owed fixed sums of money to those who owe them.
Protecting Against Inflation
- TIPS — U.S. Treasury Inflation-Protected Securities adjust principal with CPI.
- I bonds — savings bonds with a rate tied directly to inflation.
- Equities — over long periods companies pass costs through, though stocks perform poorly during inflation shocks themselves.
- Real estate — rents and values tend to track prices, and a fixed-rate mortgage is repaid in cheaper money.
- Fixed-rate borrowing — unusual but real: inflation erodes the real value of what you owe.
Limits of the CPI
The CPI is a national average of a fixed basket, and no household buys the average basket. If a large share of your spending goes on categories rising faster than the index — healthcare, education, urban housing — your personal inflation rate exceeds the published figure. The index also adjusts for quality improvements and for consumers substituting cheaper goods, both of which are defensible in principle and disputed in practice.
Frequently Asked Questions
Why does the calculator use annual averages?
Monthly CPI is volatile and seasonal. Annual averages are the standard basis for year-to-year comparisons and are what the BLS itself uses for historical purchasing-power statements.
Is deflation good?
Rarely. Falling prices raise the real value of debt, encourage consumers to delay purchases, and can produce a self-reinforcing downward spiral. Japan's experience after 1990 is the standard cautionary case.
What rate should I assume for future planning?
Between 2% and 3% is the usual planning assumption, matching central bank targets and long-run averages. Higher assumptions produce more conservative retirement plans.
Does inflation mean my salary should rise by the same amount?
A raise equal to inflation keeps purchasing power unchanged — it is not a real increase. Real wage growth requires a raise above the inflation rate.