What Is Inflation? Current Inflation Rate, Causes and How to Stay Ahead of Rising Costs (2024)

Vault’s Viewpoint on Inflation

• Inflation measures the rising prices of goods and services.
• The Consumer Price Index (CPI) is often used as the most relevant measure of inflation for how prices impact consumer finances.
• It’s possible to hedge against inflation by investing in certain assets designed to beat inflation over time.

What Is Inflation?

Inflation reflects a loss of purchasing power as prices for goods and services rise over time. When the inflation rate is high, it suggests that prices are rising rapidly, often having an immediate impact on personal finances. When experts and pundits talk about inflation going down, it often refers to a lower rate of inflation. Prices are still rising, but at a slower pace than seen in the immediate past.

It’s important to note that the opposite of inflation, deflation, represents a drop in prices accompanied by an increase in purchasing power. A reduction in the inflation rate isn’t the same thing as deflation.

Why Inflation Matters

Inflation matters because it directly impacts the purchasing power of your money. When inflation rises, the cost of goods and services increases, meaning you can buy less with the same amount of money. This erosion of purchasing power affects everyone, from consumers to businesses.

For consumers, it means higher prices for everyday items like groceries and gas, which can strain household budgets. For businesses, rising costs can lead to higher prices for their products, potentially reducing demand and affecting profitability.

Inflation also influences interest rates. Central banks, like the Federal Reserve, may raise interest rates to control high inflation, making borrowing more expensive. This can impact everything from mortgage rates to credit card interest rates.

Inflation can also erode the value of savings. If the inflation rate is higher than the interest rate on your savings account, the real value of your savings decreases over time. This makes it crucial to consider inflation when planning for long-term financial goals, such as retirement.

What Causes Inflation?

Pinpointing exact causes for inflation can be difficult because economists differ on how various factors impact inflation.

For example, some economists insist that rising wages result in inflation through a wage-price spiral because higher wages are assumed to lead to price increases as workers can afford higher prices. On the other hand, some economic research indicates that wage-price spirals don’t exist and that higher wages, rather than causing inflation, are reflections of existing inflation and provide a way for workers to afford necessities, goods and services.

Here are some of the accepted causes of recent inflation:

• An increase in money supply. When a country increases its money supply, the value of the currency drops. In the U.S., this means it takes more dollars to purchase the same amount of goods and services. Monetary authorities can increase the money supply by increasing how much it produces (prints) and gives to citizens, purchasing government bonds from banks using reserve account credits and devaluing the currency.
• Supply chain issues. In a global economy, when the supply chain is interrupted, making it more difficult to acquire raw materials or deliver goods, prices can rise. Supply chain issues during the COVID-19 crisis are cited by the San Fransisco Federal Reserve as a major cause of inflation in 2021. Additionally, concerns about global conflict and potential disruptions can impact supply chains and contribute to inflation.
• Corporate price increases. One study from the Kansas City Fed cited corporate price increases as a major contributor to inflation in 2021. Additionally, the Economic Policy Institute looked at corporate price increases as a driver of a portion of inflation. Another paper looked at how some companies take advantage of inflation to add extra price hikes, while another analysis looked at earnings calls and how CEOs bragged about using inflation as a cover to hike prices further.

Types of Inflation

Three main types of inflation are often recognized by economists: demand-pull, cost-push and built-in. Let’s take a look at each type.

Demand-Pull Inflation

In this case, access to more credit and an increase in money supply allows consumers to afford more goods and services. As a result, there’s an increase in demand for goods and services. As this demand increases—and supply becomes crunched—prices respond by heading higher.

When demand outpaces the ability of the economy to supply goods and services customers want, prices rise because those items are harder to get. As long as consumers can handle the higher prices (either by using credit or through income), they are likely to keep rising at a rapid rate.

Cost-Push Inflation

This type of inflation is theoretically driven by production costs. For example, if the cost of raw materials rises due to a global shock or some other problem, then the price to produce related goods rises. If these costs rise fast enough, it can result in a big jump in prices, contributing to inflation. Even though demand for the product might stay level, the cost heads higher because circ*mstances that affect the production process have changed.

Built-In Inflation

This is inflation that is essentially baked into the system. We expect prices to rise, and we accept price increases as part of increased economic activity and as part of the business cycle. Historically, inflation tends to average between 2% and 4% annually.

But there are times when inflation is much higher. Inflation in 1980 reached above 13% and there was a great deal of consternation when inflation was above 6% in 2022. The Federal Reserve attempts to limit inflation to 2%, using various monetary policy levers, but it doesn’t always work.

The idea that some degree of inflation is preferable for our economy is one potential manifestation of built-in inflation.

How to Calculate Inflation Rate

Figuring out the inflation rate is fairly straightforward. For an individual item, you subtract the original cost from the current cost. Then you divide that answer by the original cost and multiply by 100.

Let’s say an item cost $60 back in April of 2000. Today, in April 2024, that same item costs $105. You’d start with 105 – 60 = $45. After dividing 45 by 60, you get 0.75, or 75%. That one item has seen an inflation rate of 75% since 2000.

Use the same principle to calculate the overall inflation rate. The Consumer Price Index (CPI) calculates the rate for a basket of goods from one month to the next and year over year. But it’s also important to note that the Bureau of Labor Statistics, which uses CPI calculations, might also adjust the results seasonally or make other tweaks.

But you can still perform the calculation. For example, if you look at CPI-U data, you might see that the total cost of the measured basket of goods and services is 299.170 in January 2023 and 308.417 in January 2024.

Follow the same steps by starting by subtracting the original total from the current total (308.417 – 299.170) to get 9.247. Divide 9.247 by 299.170 to get 0.0309, or 3.1% when multiplied by 100 and rounded to the nearest first decimal place. So the year-over-year inflation rate from January 2023 to January 2024, without seasonal adjustments, was 3.1% as measured by the CPI-U.

Different Inflation Measures

We base the inflation rate on various indexes that measure different prices. As a result, the rate might appear different, depending on what’s being measured. There are three main indexes used to get a picture of inflation:

• Consumer Price Index (CPI): This is a weighted basket of prices related to consumer goods and services. There are two versions: CPI-U, which measures what you’ll see for all urban consumers, and CPI-W, which measures what urban wage earners and clerical workers are paying. When we talk about inflation, much of the time the reference is to CPI-U.
• Producer Price Index (PPI): Represents the costs to producers. It’s what they pay to access raw materials and supplies. The CPI focuses on price changes from a consumer perspective, while the PPI looks at the situation from a seller perspective.
• Wholesale Price Index (WPI): The items included in the WPI vary by country, and it looks at things from wholesale and/or producer perspective. The United States relies more on the PPI than it does on the WPI.

All three of these indexes offer some insight into what’s happening with prices and can assist policymakers as they try to decide how to manage economic growth.

When Will Inflation Go Down?

It’s hard to say when inflation will go down. As of the end of April 2024, inflation is more in line with historical levels, as it has slowed. The most recent statement from the Federal Reserve, which aims to get inflation at 2%, indicates that there won’t be rate cuts any time soon.

That makes sense because one way the Fed slow inflation is by raising its benchmark rate. When rates are higher, borrowing money is more expensive, slowing the rate at which people buy goods and services, reducing demand and keeping inflation in check.

If the Fed remains committed to its course, there is a chance that inflation will fall to its 2% target by the end of the year. But we are unlikely to see deflation, which is a reduction in prices. Instead, prices will still rise over time, but at a slower and—hopefully—more manageable rate that consumers can handle.

How to Protect Against Inflation

If you want to hedge against inflation, choosing assets that offer returns that beat inflation can help. When you simply let your money sit in a regular bank account, your dollars will lose purchasing power due to inflation. As a result, it makes sense to diversify your portfolio and make sure you’re building a nest egg designed to beat inflation over time.

High-Yield Savings Account

When inflation is high, and the Fed raises its benchmark, many savings accounts pay higher yields. Some of the best high-yield savings accounts currently offer APYs above 5%. The average yield for a traditional savings account is 0.45%.

By moving your money to a high-yield savings account, your emergency fund or other savings can beat inflation. But you should note that as inflation cools and the Fed begins cutting rates again, your yield will also fall. But it should still likely provide a hedge against inflation. For more information, check out our up-to-date average savings account rates.

Certificates of Deposit (CDs)

Like high-yield savings accounts, certificates of deposit (CDs) offer a place to park your cash while potentially beating inflation. CDs are time deposits, though, so you have to lock up the money for a set period of time. Check the best CD rates to see which terms offer the best yields and consider getting a variety of terms so you can take advantage of changing rates in the future. Make sure to stay ahead by tracking current CD rates.

Inflation-Protected Treasury Bonds

If you want to invest in a safe asset that keeps pace with inflation, you have two Treasury options:

• Series I Savings Bonds (I bonds): Buy savings bonds on Treasury Direct in increments of $25, up to $10,000 per year per Social Security number for electronic bonds. You can also use your tax refund to purchase up to an additional $5,000 in paper I-bonds. These bonds have a low fixed rate, and then another rate set every six months, based on inflation. For I bonds issued between May 1, 2024, and October 31, 2024, the rate is 4.28%—which beats inflation.
• Treasury Inflation-Protected Securities (TIPS): Buying these Treasuries can help protect you against inflation. The principal of TIPS can change during the course of the term, but you always get back at least what you put in. The interest is fixed but paid on an adjusted principal, so interest received every six months reflects that.

Other Treasury bonds currently have yields that beat inflation, but those rates are fixed, so if inflation spikes again in the future, your buying power might not be protected.

Real Estate

Often considered a hedge against inflation, real estate gives you the chance to capture appreciation over time. If you believe the housing market will grow at a rate that beats inflation, your home can be a hedge against inflation. Others choose to invest in rental properties and receive regular cash flow from tenants as well as potentially capture appreciation in the future. Finally, if you’re not interested in buying property directly, a real estate investment trust (REIT) offers access to liquid shares and exposure to real estate.

Invest in the Stock Market

Historically, the S&P 500 has returned close to 10% on an annualized basis. While actual returns can vary month-to-month and year-to-year, over time, investing in the stock market as a whole has been a reasonable hedge against inflation. You can use a variety of tax-advantaged investment accounts to help you build wealth at a more rapid rate, using your nest egg to preserve your purchasing power in the future.

Even short term, using the stock market for a portion of your emergency fund or other purposes can help you beat inflation.

Alternative Investments

Alternative investments are also considered inflation hedges by many investors. They can offer inflation-beating returns even when stocks are down.

Some alternatives include:

• Gold and precious metals: Gold has long been considered a hedge against the declining value of the U.S. dollar. Other precious metals, like silver and platinum, can also act as hedges. You can purchase high-quality precious metals from reputable sellers, but you might have to pay a premium and figure out how to store them.
• Commodities: Other commodities, like crude oil, natural gas, agricultural products and other metals can also be used to hedge against inflation. It takes some effort to learn how to trade commodities contracts and futures, as well as options, so take your time when focusing on these alternatives.
• Cryptocurrencies: In some cases, cryptocurrencies are still offering reasonably high returns, especially “blue chips” like Bitcoin (BTC) and Ethereum (ETH). If you think that holding some crypto could help your ability to beat inflation, it might not be a bad addition to your portfolio.

Depending on the situation and how risky the assets are considered, it might make sense to take profits as you can and then put those profits elsewhere. Carefully review your strategy and portfolio needs as you decide how to use alternative investments to hedge against inflation.

You can use multiple strategies to hedge against inflation, by diversifying your portfolio to match your risk tolerance while investing in different inflation-beating assets.