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1 1 (January 5, 2023)

handle is hein.crs/govekbt0001 and id is 1 raw text is: Congressional Research Service nforming qh IiiI gislative debt sInt 1914 Introduction to U.S. Economy: Inflation What Is Inflation? Inflation is defined as a general increase in the price of goods and services across the economy, or, in other words, a general decrease in the value of money. Conversely, deflation is a general decrease in the price of goods and services across the economy, or a general increase in the value of money. As inflation occurs, individuals can purchase fewer goods and services with the same amount of money. For this reason, an individual would need about $326 in 2021 to purchase the same amount of goods and services as $100 would have purchased in 1980. Measures of inflation are used to adjust money figures to keep purchasing power constant over time, allowing for more accurate comparisons across disparate time periods. Monetary figures that have been adjusted for inflation are referred to as real, and non- inflation-adjusted figures are referred to as nominal. Measuring Inflation The rate of inflation can be measured by observing changes in the average price of a consistent set of goods and services, often referred to as a market basket. Inflation is generally measured using a price index, such as the Consumer Price Index (CPI). A price index is constructed by dividing the price of a market basket in a given year by the price of the same basket of goods in a base year. The rate of inflation is then measured by calculating the percentage change in the price index across different periods. For example, the CPI was about 277 in October 2021 and about 298 in October 2022, which amounts to an inflation rate of about 7.8% over this 12-month period. Alternative Measures of Inflation Alternative price indices will use different goods within their market baskets and are generally used for different purposes. For example, the CPI includes consumer goods and services typically purchased by households, which is often used to adjust household incomes for inflation over time. By contrast, the gross domestic product (GDP) deflator, which is generally used to adjust GDP for inflation over time, measures inflation for all of the final goods and services produced in the United States. There are a number of additional measures of inflation, including the Producer Price Index, Employment Cost Index, Personal Consumption Expenditures Index, and Import/Export Price Index. Different inflation measures are calculated differently. For example, the CPI uses a (mostly) fixed basket of goods and services, whereas the GDP deflator allows the composition of its market basket to change with spending patterns from period to period. Additionally, within a specific price index, researchers often make separate calculations for so-called headline inflation and core inflation, as seen in Figure 1. Headline Updated January 5, 2023 inflation includes the full set of goods and services within the basket of goods, whereas core inflation excludes energy and food prices from the basket of goods. Core inflation is often used by researchers in place of headline inflation due to the volatile nature of the price of food and energy. Headline inflation can provide a more accurate sense of the price changes actually faced by individuals. Figure I Annual Inflation Rate January 1960 to November 2022 12% 10% -2% -4% - - - - - 1960 1966 1973 1980 1937 1994 2001 2003 2015 2022 Source: Bureau of Economic Analysis. Notes: Annual percentage change as measured by Personal Consumption Expenditures Index. Complications in Measuring Inflation The fundamental concept behind inflation is to measure changes in the price of the same goods and services over time. In reality, this is nearly impossible for two reasons. First, the quality of goods and services change over time. As such, some portion of increasing prices over time is due to improvements in quality rather than inflation. Second, new products are introduced into the marketplace over time that are fundamentally different than any previously available products and are only slowly incorporated into price indices with fixed baskets. Statistical agencies try to adjust data to account for these factors, because, if these complications are not correctly accounted for, measured inflation would be inaccurate and most likely overstated. Causes of Inflation Inflation is largely the result of two different phenomena, which are often referred to as demand-pull and cost-push inflation. Demand-pull inflation occurs when demand for goods and services within the economy exceeds the economy's capacity to produce goods and services. As demand exceeds supply within the economy-too much money chasing too few goods-there is upward pressure placed on prices, resulting in rising inflation. Cost-push inflation occurs when the price of input goods and services increases. The classic example of cost-push inflation is the result of an oil shock, which sharply

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