Inflation

Background

One of the biggest challenges that can afflict an economy, inflation is a monetary phenomenon wherein prices broadly rise and consumer purchasing power declines. From a practical perspective, it means your dollar doesn’t stretch as far as it did the day before.

In the US, the inflation rate has generally been around 2%-3% per year since 1960, with a handful of notable spikes, and prices have risen nearly continuously since then. A dollar one century ago was worth $18 in 2024 terms; try out an inflation calculator here.

Causes

How quickly prices rise—or in some cases, fall—is rarely constant and is affected by a variety of factors.

In principle, anything that increases demand (more consumers wanting to buy goods or services) relative to supply (the amount of said goods or services available) can be inflationary. The former can arise from things like rising wages or central banks printing new currency, while the latter may be influenced by issues like labor costs or supply chain disruptions.

Economies are complex and dynamic—a wide variety of things may cause inflation. See a breakdown of common drivers here.

In the US, some inflation is built into federal monetary policy. The Federal Reserve, the country’s central bank, targets 2% inflation. The number is somewhat arbitrary but is intended to maintain a predictable and low rate of rising prices, allowing companies and households to plan for the future.

Economists also worry about deflation. While falling prices and a stronger currency may seem positive, they can spark a deflationary loop (see more here). In such a scenario, demand drops as consumers expect prices to continue falling, which causes profits to fall and unemployment to rise, leading to falling incomes and further decreasing demand.

Those in charge of monetary policy therefore seek a delicate balance between demand and supply to promote small inflationary effects in the economy.

Examples

Inflation in the US can generally be split into two eras—before and after the establishment of the Federal Reserve, the US central bank. Prices remained relatively constant until around the mid-1920s, after which they rose dramatically to the modern day.

Exact inflation rates in early America are difficult to calculate precisely, though the highest inflation in US history was said to be in 1778, just after the Revolutionary War, at close to 30%. Both World Wars brought double-digit inflation, while the Great Depression saw severe deflation as the money supply shrunk by 30%.

In the 1970s, the US experienced what is known as stagflation, or the combination of inflation, high unemployment, and slow economic growth. Policymakers at the Federal Reserve embarked on a yearslong strategy of high interest rates to tighten the money supply.

Under certain conditions, prices can undergo rapid increases resulting in hyperinflation. Venezuela, which has suffered long-running inflation since the 1980s, has seen extreme runaway prices since 2018 as citizens lost confidence in the national currency as a store of value (deep dive here).

Future

Economists largely agree some small, stable amount of inflation is desirable, and most central banks set inflation targets that they attempt to control via the interest rates and money supply. Still, global economies remain subject to large-scale events that can trigger inflation—wars, natural disasters, pandemics, supply chain disruptions, and more.