Price Inflation

Oh, Grandma. You say I’m so rich with my salary. But you haven’t left your house in forty years and don’t do your own shopping. Milk used to be a nickel; now it’s three dollars. A burger used to be a dime; now they’re six dollars. Plus you didn’t even have student loans to pay, and you owned a house at my age. I’m not rich. Inflation, Grammy. Inflation!

Price inflation is when the prices of goods and services rise, often expressed as baskets of goods per year. The Consumer Price Index has lots of baskets, like education, transportation, food—all the stuff most people buy regularly. It’s “inflation,” because incomes rise, too. When prices and income both rise together at the same rate, then buying-power stays relatively the same. This is what Grandma doesn’t understand. Tell her inflation is so important that the Federal Reserve uses it to set monetary policy. If inflation is too high, that’s dangerous...so banks will increase interest rates. If it’s low, then the Fed can lower interest rates. See, Grandma...see? Price inflation is real.

So what’s the point of inflation if everything stays the same-ish? Your income goes up, but if prices go up, then you’re back where you started anyway.

There are only theories to explain inflation, but one is that, as there’s more money pumped into the economic system from growth, it creates more dollars to buy more things. Which means there’s a higher supply of money than goods demanded, making prices rise, and incomes in turn.