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Rising prices have dominated economic headlines and household budgets in recent years. After decades of relatively stable costs, Americans suddenly found themselves paying dramatically more for everything from groceries to gasoline.
Understanding why this happened, how it’s measured, and what it means for your wallet requires looking beyond simple explanations.
What Inflation Means
Inflation is the general and sustained increase in prices across an entire economy over time. The Federal Reserve defines it not by individual price changes—like milk or gasoline costs—but by broad rises in the overall price level measured by the Department of Labor.
This distinction matters because inflation directly reduces purchasing power. Each dollar buys less than it did before. If a grocery basket that cost $100 last year now costs $105, the economy has experienced 5% inflation, as explained by the Cleveland Federal Reserve.
The erosion of purchasing power affects everyone differently. Workers, business owners, lenders, and retirees on fixed incomes all feel distinct impacts. The phenomenon influences major financial decisions and can reduce the real value of savings and investments, according to Investopedia’s analysis.
Economists distinguish between nominal and real values to capture this effect. Your nominal income is the dollar amount on your paycheck. Your real income is what you can actually purchase with that money after accounting for price changes. If your nominal income rises by 3% in a year but inflation runs at 4%, your real income has actually fallen by 1%, as detailed in Congressional Research Service reports.
The Fed’s Target
The Federal Reserve aims to maintain stable, low inflation, officially targeting an annual increase of 2%. This target isn’t zero because small, predictable inflation is considered healthy for modern economies. It encourages timely spending and investment while making it easier for wages and prices to adjust to changing economic conditions, as EconoFact research explains.
When households and businesses can reasonably expect inflation to remain low and stable, they can make better financial plans, contributing to economic stability.
Public awareness of inflation becomes an economic force itself. When prices rise noticeably, public attention spikes—measured by indicators like Google searches for “what is inflation”—according to Google’s business insights. This matters because expectations about future inflation can become self-fulfilling prophecies.
If people expect continued price rises, workers may demand higher wages and businesses may raise prices preemptively. This “expectations channel” can make inflation more persistent, as Federal Reserve Chair Jerome Powell noted when inflation had “just about everyone’s attention,” increasing the risk of it becoming entrenched in the economy.
How Government Measures Price Changes
To track general price increases, government agencies monitor the cost of representative “market baskets” of goods and services that consumers typically buy. The percentage change in this basket’s cost over time becomes the inflation rate. Two primary price indexes serve this purpose: the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) price index.
The Consumer Price Index
The CPI, published monthly by the Bureau of Labor Statistics, is the most widely recognized consumer inflation measure. It tracks the average change over time in prices paid by urban consumers for a fixed market basket covering about 93% of the US population, as Investopedia details.
The CPI’s influence is enormous. The government uses it for Social Security cost-of-living adjustments, federal income tax bracket adjustments, and government assistance eligibility determinations, directly affecting hundreds of millions of Americans through BLS calculations.
Constructing the CPI requires massive data collection. The BLS determines market basket contents and each item’s relative importance based on detailed expenditure surveys of thousands of American families and individuals, according to their questions and answers page.
This comprehensive basket organizes into eight major groups: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. To track price changes, the BLS collects approximately 94,000 prices and 8,000 rental housing quotes monthly from thousands of retail outlets, service establishments, and rental units nationwide.
The CPI includes sales and excise taxes directly associated with purchases but excludes investment items like stocks, bonds, and real estate, as well as income and Social Security taxes, focusing on day-to-day consumption expenses.
The Fed’s Preferred Measure
The PCE price index, produced by the Bureau of Economic Analysis, measures prices of goods and services purchased by or on behalf of all US households. While the CPI is more publicly recognized, the PCE index serves as the Federal Reserve’s primary inflation gauge for monetary policy and its official 2% target.
The Fed prefers the PCE index due to several methodological differences that provide what it considers a more comprehensive and accurate picture of underlying inflation trends. First, the PCE’s scope is broader, including not only household out-of-pocket expenses but also expenditures made on their behalf, such as employer-sponsored health insurance or government-financed medical care, as detailed in BEA methodology documents.
More importantly, the PCE index uses a formula accounting for changes in consumer behavior. It captures the substitution effect—consumers’ tendency to shift spending away from items with rising prices toward cheaper alternatives. If beef prices rise sharply, consumers may buy more chicken. The PCE index’s dynamic weighting reflects this shift, while the CPI’s fixed basket adapts more slowly, according to Investopedia’s PCE analysis.
These differences mean the PCE index often shows slightly lower inflation rates than the CPI.
Key Differences Between CPI and PCE
| Attribute | Consumer Price Index (CPI) | Personal Consumption Expenditures (PCE) Price Index |
|---|---|---|
| Issuing Agency | U.S. Bureau of Labor Statistics (BLS) | U.S. Bureau of Economic Analysis (BEA) |
| Primary Data Source | Surveys of households on out-of-pocket spending (BLS Q&A) | Business surveys on sales, plus government and other sources (BEA methodology) |
| Scope | Measures out-of-pocket spending by urban consumers | Measures all household spending and spending on behalf of households |
| Weighting Formula | Uses relatively fixed “market basket” updated periodically | Uses dynamic, chain-weighted formula accounting for consumer substitution (FRED data) |
| Key Takeaway | Better measure of direct cost of living for typical urban households; used for Social Security and tax bracket adjustments | Federal Reserve’s preferred gauge because it’s broader and captures behavioral changes, providing better view of underlying economic trends |
This technical distinction has significant real-world consequences. Social Security benefits index to the CPI (specifically, the CPI-W subset), while the Federal Reserve bases economy-wide interest rate decisions on the PCE index. This can create policy disconnects where the central bank sees more subdued inflation than retirees and other beneficiaries whose incomes tie to the CPI experience.
Headline vs Core Inflation
“Headline” inflation refers to the rate calculated using the entire market basket, including all goods and services. It represents actual, overall price changes consumers face daily, as tracked by USA Facts.
Policymakers and economists often focus on “core” inflation, which excludes volatile food and energy categories. Prices for these items can swing dramatically due to factors having little to do with underlying economic health, such as weather events affecting crops or geopolitical conflicts impacting oil supply.
By removing these volatile components, core inflation provides clearer signals of more persistent, underlying inflation trends that monetary policy can better address, as the Bureau of Economic Analysis explains. The goal isn’t ignoring real pain from high gas and grocery prices but distinguishing temporary price shocks from durable inflationary problems across the broader economy.
What Caused the Recent Price Surge
The inflation spike beginning in 2021 resulted from complex, overlapping economic forces—a “perfect storm” that simultaneously boosted demand and constrained supply. The Congressional Budget Office analysis shows this inflationary period was unique because it was driven powerfully by both demand-pull and cost-push factors simultaneously.
Too Much Money Chasing Too Few Goods
Demand-pull inflation occurs when total demand for goods and services outstrips available supply. When consumers, businesses, and government all try to buy more than the economy can produce, prices face upward pressure—often described as “too many dollars chasing too few goods,” according to Investopedia’s demand-pull analysis.
The Pandemic Spending Shift
One major driver was a massive, abrupt shift in consumer behavior. During pandemic lockdowns and social distancing periods, spending on in-person services—dining out, travel, entertainment, transportation—plummeted. Households redirected this unspent money toward physical goods, particularly electronics, furniture, cars, and home improvement supplies, as detailed in Boston Fed research.
This created a concentrated surge in demand for goods that production capacity was unprepared to handle, especially as supply chains faced their own pandemic-related disruptions.
Government Stimulus Impact
To prevent economic collapse during the pandemic, the US government deployed unprecedented fiscal stimulus. Through legislation like the CARES Act and American Rescue Plan, trillions of dollars were injected into the economy via stimulus checks, enhanced unemployment benefits, and business relief programs, as documented in academic research.
This support successfully prevented deep recession but also directly fueled consumer demand surges. With more cash on hand, households increased spending, particularly on goods consumed while stuck at home. Federal Reserve research suggests fiscal support boosted goods consumption without corresponding production increases, widening the demand-supply gap and contributing significantly to inflationary pressures. One study estimated US fiscal stimulus alone added about 2.5 percentage points to inflation.
Rising Production Costs
Simultaneously, the economy’s ability to supply goods and services was severely hampered, leading to cost-push inflation. This occurs when production costs—for raw materials, energy, shipping, and labor—increase. Businesses pass these higher costs to consumers through higher prices to protect profitability.
Global Supply Chain Chaos
COVID-19 wreaked havoc on intricate global supply chains that modern economies depend on. Factory shutdowns, labor shortages due to illness, and public health restrictions slowed worldwide production. This was compounded by severe logistical bottlenecks, including massive shipping port congestion and truck driver shortages, causing long delays and staggering transportation cost increases, as detailed in White House Council of Economic Advisers reports.
At their peak, spot prices for shipping containers from China to the US West Coast surged to more than 10 times pre-pandemic levels. These disruptions created shortages of key components, from lumber to microchips, and were primary drivers of goods price spikes seen in 2021, according to Brookings Institution analysis.
Energy Price Shocks
Energy is a foundational cost for nearly every economic sector. Strong global economic recovery from the pandemic increased oil and natural gas demand. This demand-side pressure met a major supply-side shock in February 2022 when Russia invaded Ukraine.
The resulting conflict and sanctions on Russia, a major global energy producer, caused sharp spikes in global energy prices, as documented in US Bank analysis. Effects were felt immediately by American consumers at gas pumps and in utility bills, but also rippled throughout the economy, increasing manufacturing, agriculture, and transportation costs that were passed to consumers in nearly all goods and services prices.
Labor Market Tightness
As the economy reopened, businesses scrambled to rehire workers to meet surging consumer demand. This led to a historically tight labor market, with job vacancies far exceeding unemployed people seeking work, as Brookings research shows.
This intense competition for labor gave workers significant bargaining power, leading to strong wage growth documented in Bureau of Labor Statistics releases. While higher wages benefit workers’ incomes, they also represent significant costs for businesses, particularly in labor-intensive service industries. Many firms passed these higher labor costs to customers, contributing to inflation persistence, especially in services, even after goods inflation began cooling.
The Shifting Nature of the Problem
A crucial feature of this inflationary period was how primary drivers shifted over time. Congressional Budget Office analysis shows that in 2021, the surge was led by goods inflation, fueled by the collision of stimulus-driven demand and snarled supply chains.
By 2022, this dynamic began changing. As supply chains started healing and consumers shifted spending back toward services, goods inflation moderated. Simultaneously, services inflation, particularly for housing and rent, accelerated and became the dominant driver of overall inflation.
This “whip-saw” effect, moving from a goods-driven problem to a services-driven one, made the situation particularly challenging for policymakers. The initial supply chain bottleneck problem began resolving but was replaced by a more persistent issue rooted in tight labor markets and rising wages, helping explain why early predictions of “transitory” inflation proved incorrect.
Understanding Corporate Pricing Power
Public debate during this time often included accusations of “corporate greed” or “greedflation” as the primary cause of rising prices. While firms make the proximate decision to raise prices, deeper economic analysis focuses on market conditions that enable such increases, as Richmond Fed research explains.
Businesses generally always seek to maximize profits. The unique 2021-2022 environment gave them extraordinary pricing power. With demand high, consumers flush with stimulus cash, and widespread goods shortages, firms could raise prices significantly without fear of losing customers. Furthermore, widely reported increases in their own costs for materials, shipping, and labor provided clear justification for price hikes.
The inflation surge was less about sudden changes in corporate character and more about changed economic conditions that dramatically increased firms’ opportunity to raise prices.
Key Factors Summary
| Demand-Side Factors (“Too Much Money…”) | Supply-Side Factors (“…Chasing Too Few Goods”) |
|---|---|
| Consumer Spending Shift: Pandemic lockdowns forced household spending from services to goods, creating concentrated demand surge | Supply Chain Disruptions: Factory shutdowns, port backlogs, and shipping shortages created scarcity and drove up costs |
| Government Stimulus: Trillions in relief funds boosted household income and savings, directly fueling higher goods consumption | Energy Price Shocks: Ukraine war and other factors spiked global oil and gas prices, increasing transportation, manufacturing, and utility costs |
| Strong Labor Market: Rapid recovery led to high employment and rising wages, giving households more money to spend | Labor Shortages: Mismatch between labor demand and supply forced businesses to increase wages, raising operating costs |
How Government Fights Inflation
In the United States, responsibility for managing the economy and combating inflation is shared between the Federal Reserve, which conducts monetary policy, and the federal government (Congress and President), which controls fiscal policy.
The Federal Reserve’s Approach
The Federal Reserve operates under a “dual mandate” from Congress: promote maximum employment and stable prices, as explained in Fed educational materials. The Fed defines “stable prices” as maintaining an average 2% inflation rate over the long run, measured by the PCE price index.
Interest Rates as the Primary Tool
The Fed’s principal inflation-fighting tool is its ability to influence interest rates. Specifically, it sets a target range for the federal funds rate—the rate at which commercial banks lend to each other overnight.
When the Fed wants to fight inflation, it engages in “tightening” monetary policy by raising its federal funds rate target. This triggers a cascade effect, pushing up interest rates across the economy for mortgages, auto loans, credit cards, and business loans. Higher borrowing costs discourage spending by households and businesses, reducing overall demand, cooling the economy, and ultimately helping bring inflation under control, as the Cleveland Fed explains.
Recent Strategy Changes
In response to the inflation surge beginning in 2021—which proved much higher and more persistent than initially anticipated—the Federal Reserve embarked on one of its most aggressive monetary tightening campaigns in decades, raising its policy rate sharply starting in March 2022, as documented in CEPR analysis.
This experience prompted significant re-evaluation of the Fed’s overarching strategy. In August 2025, the Fed completed a review of its monetary policy framework and announced key changes to the strategy adopted in 2020, detailed on the Fed’s policy review page.
The 2020 framework had been designed for persistently low inflation and focused on preventing interest rates from getting stuck at zero. The post-pandemic reality of high inflation rendered that framework “irrelevant,” in Chair Powell’s words, according to Brookings Institution analysis.
The revised 2025 framework returned to a more traditional, flexible inflation-targeting approach. It eliminated the pledge to seek an “average” 2% inflation rate over time (which would have required above-target inflation periods to make up for past shortfalls) and removed language creating asymmetrical responses to employment goals.
The new framework re-emphasizes a “balanced approach” when maximum employment and price stability goals conflict and stresses the critical importance of acting forcefully to ensure long-term inflation expectations remain firmly anchored at 2%, as outlined in Powell’s Jackson Hole speech.
The Challenge of Timing
This policy-making process is fraught with difficulty due to what economists call “long and variable lags.” The effects of Fed interest rate decisions aren’t felt immediately; it can take a year or more for them to fully work through the economy and impact inflation, as Investopedia explains.
This means the Fed must act based on economic forecasts, not current conditions. In 2021, the forecast that inflation would be transitory led the Fed to keep policy loose too long. Conversely, when tightening aggressively, the Fed faces the risk that lagged effects of rate hikes could tip the economy into recession long after inflationary pressures have started fading.
This timing challenge explains why achieving a “soft landing”—reducing inflation without causing significant unemployment increases—is notoriously difficult.
Congressional and Presidential Tools
While the Federal Reserve wields monetary policy, Congress and the President control fiscal policy—using government spending and taxation to influence the economy, as the Committee for a Responsible Federal Budget explains.
Fiscal Policy Tools
To combat inflation, the government can employ contractionary fiscal policy through several approaches:
Reducing Government Spending: When government cuts its own spending on goods and services, it directly reduces aggregate demand in the economy, as detailed in Congressional Research Service reports.
Increasing Taxes: Raising taxes on individuals or corporations reduces their disposable income, leaving less money for spending and investment, which also dampens aggregate demand, according to CRS analysis.
Reducing Transfer Payments: Scaling back government transfers to individuals, such as unemployment benefits or subsidies, can also reduce household spending.
The Case for Policy Coordination
Many economists argue that fighting inflation is most effective when monetary and fiscal policy work together rather than at cross-purposes. If the Fed is “hitting the brakes” with higher interest rates while Congress is “hitting the gas” with deficit-financed spending or tax cuts, it can undermine central bank efforts and force even higher rates than otherwise necessary. This increases recession risk and adds to national debt.
Conversely, when contractionary fiscal policy helps cool demand, it can complement Fed actions. This allows the Fed to rely less heavily on interest rate hikes, mitigating economic pain in interest-rate-sensitive sectors like housing and auto sales. Furthermore, fiscal policy can address the economy’s supply side—through policies encouraging labor force participation or boosting investment—which can ease long-term inflationary pressures without simply suppressing demand.
How Rising Prices Affect American Families
The macroeconomic forces of inflation and government policies to fight it have profound consequences for American families’ financial well-being. The impact appears through changes in purchasing power, wages’ ability to keep pace with costs, and savings and retirement security.
Are Wages Keeping Up?
A central question for working families during high inflation is whether paychecks keep up with rising living costs. This requires looking beyond nominal (dollar value) wage increases to real (inflation-adjusted) wage growth, as tracked by Bureau of Labor Statistics data.
Recent trends show a mixed picture. During peak inflation in June 2022, prices rose at a staggering 9.1% annual rate while nominal average wages grew by only 4.8%. This resulted in a significant 4.3 percentage point decline in real wages, meaning average workers’ purchasing power was shrinking rapidly, as USA Facts analysis shows.
However, as inflation cooled, the dynamic reversed. Data from July 2025 shows nominal average weekly wages increased by 4.2% over the previous year while inflation fell to 2.7%. This resulted in a 1.5% increase in real wages, indicating average workers’ purchasing power was growing again.
Over the long run, inflation’s corrosive effect is clear: since March 2006, the nominal average weekly wage in the US rose by 82.3%, but after adjusting for inflation, the real increase in purchasing power was only 12.7%.
Inflation’s Unequal Impact
National averages mask a critical reality: inflation doesn’t affect all households equally. Substantial evidence shows inflation disproportionately harms lower-income households, effectively acting as a regressive tax that exacerbates economic inequality, according to Dallas Fed research.
The primary reason for this disparity is different spending patterns. Lower-income families spend much larger shares of their budgets on necessities like food, energy (gasoline and utilities), and rental housing—categories that often experience the most dramatic price increases, as Penn Wharton Budget Model analysis shows.
Higher-income households spend greater proportions of income on discretionary services and other items where price increases have been more moderate.
This “inflation gap” is quantifiable. A 2021 Penn Wharton study found the lowest 20% of households by income had to increase spending by 6.9% to maintain their standard of living, while the top 5% needed to increase spending by only 6.1%.
Research from the Bureau of Labor Statistics covering 2006 to 2023 confirms this trend, finding the lowest-income quintile consistently faced higher average annual inflation rates than the highest-income quintile, as detailed in BLS research.
Impact by Income Level
| Income Group (Quintile) | Additional Annual Spending Required (2021) | Percentage Increase in Total Spending |
|---|---|---|
| Bottom 20% | ~$2,160 | 6.9% |
| Middle 20% (40%-60%) | ~$3,700 | 6.9% |
| Top 20% | ~$5,800 | 6.1% |
Source: Analysis based on Penn Wharton Budget Model data
This persistent gap silently erodes the purchasing power of the most vulnerable households and widens real income gaps between rich and poor. While tight labor markets have led to stronger nominal wage gains for low-income workers since 2019, these gains are partially offset by the higher inflation they face, according to JP Morgan Chase Institute research.
The financial stress is palpable; even as aggregate real wages began rising, a 2022 survey found nearly half of all Americans felt “very stressed” by inflation, a burden falling heaviest on those least able to bear it.
The Challenge for Savers and Retirees
Inflation poses particularly acute threats to long-term financial security by eroding savings value and straining budgets of those on fixed incomes.
Savings Erosion
For savers, inflation is a silent thief. Cash held in savings accounts, checking accounts, or under mattresses loses purchasing power every day inflation is positive, as detailed in Department of Labor reports. This discourages saving, as money’s future value diminishes. It can be especially damaging for emergency funds and households less likely to invest in assets that hedge against inflation.
Retirement Impact
Retirees are among groups most vulnerable to high inflation, according to Center for Retirement Research analysis. Many rely on income sources that are fixed or don’t fully adjust for rising living costs.
While Social Security benefits are indexed to inflation annually via cost-of-living adjustments (COLA), other crucial retirement income sources, such as private-sector defined benefit pension plan payments, often are not. This means millions of retirees see their income remain flat while costs for everything from healthcare to food rise, forcing them to draw down savings more quickly than planned.
Inflation also impacts retirement portfolios. While assets like stocks and real estate generally provide some long-term inflation protection, fixed-income assets like bonds—often held in greater proportion by older, more conservative investors—can see their real value decline sharply when inflation and interest rates rise.
The Persistent Challenge
The inflation surge that began in 2021 demonstrated how quickly price stability can be disrupted when multiple economic forces align. While inflation has cooled from its peaks, the experience has reshaped understanding of how modern economies respond to extraordinary shocks.
The episode revealed both the power and limitations of government tools for managing prices. Monetary policy proved effective at eventually bringing inflation down, but at the cost of significant economic uncertainty and the risk of recession. Fiscal policy played a crucial role in both creating and potentially solving inflationary pressures, highlighting the importance of policy coordination.
For American households, the inflation experience underscored how quickly purchasing power can erode and how unequally these effects are distributed across the population. Lower-income families, savers, and retirees faced disproportionate burdens, while some workers and asset holders benefited from the tight labor markets and rising asset values that accompanied the inflationary period.
Looking ahead, the challenge for policymakers is maintaining the delicate balance between supporting economic growth and employment while keeping prices stable. The recent experience suggests this balance is more fragile than previously understood, requiring constant vigilance and perhaps new approaches to economic management.
The inflation story of the 2020s serves as a reminder that price stability, once lost, can be difficult and costly to restore. Understanding these dynamics—how inflation develops, how it’s measured, and how it affects different groups—remains essential for navigating an uncertain economic future where the next price shock may come from directions not yet imagined.
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