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What is inflation, and how does the Federal Reserve evaluate changes in the rate of inflation?
The Federal Reserve Board defines inflation as “the increase in the prices of goods and services over time.” It stresses that a rise in the price of one product—or even several—is not enough: inflation describes a general increase in the overall price level. A sudden jump in the price of eggs, for example, may affect household budgets without showing that prices across the economy are rising at the same pace.
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Inflation is a rate of change over a stated period, not the price level itself. If inflation falls from one period to another, prices may still be increasing; they are simply rising more slowly. A return to lower inflation does not ordinarily mean prices have returned to their earlier levels.
The Federal Reserve monitors several measures, including the Personal Consumption Expenditures (PCE) price index, the Consumer Price Index (CPI), and producer price indexes. Its longer-run inflation objective is 2 percent per year, measured by the PCE price index. That is the U.S. Federal Reserve’s objective, not a universal target for every country or central bank. Federal Reserve: What is inflation, and how does the Federal Reserve evaluate changes in the rate of inflation?
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How are inflation figures measured?
Statistical agencies track prices for a selected basket of goods and services and combine the changes into an index. The percentage change in that index over a specified period is an inflation rate. CPI and PCE both measure price changes related to consumption, but they use different coverage and methods. Their rates can differ, so always identify the index and comparison period when quoting a figure.
| Measure | What it covers and how it is constructed | What it helps answer |
|---|---|---|
| CPI | Tracks prices of consumer goods and services. It weights price changes using average household spending on products; its basket is mostly held constant for consistency and adjusted periodically. National statistical offices, labor ministries, or central banks commonly produce official CPIs. | How the cost of a representative household-consumption basket changes. CPI is widely used and often available frequently and promptly; it can also inform adjustments to wages, rents, interest, benefits, and pensions. |
| PCE price index | Covers a broad range of household spending and adapts more quickly to changes in spending patterns than CPI. | How prices change across a broad measure of household consumption. The Federal Reserve uses PCE inflation for its longer-run 2 percent objective. |
| GDP deflator | Measures prices of goods and services produced domestically; its contents vary with what is produced and include items that are not consumer purchases. | How prices change for domestic production, rather than just household consumption. |
These distinctions matter in practice. A CPI rate is not interchangeable with a PCE rate, and a GDP deflator answers a broader production-price question. The IMF’s Consumer Price Index Manual: Theory, 2025 explains CPI theory and measurement in greater technical detail.
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What is the difference between inflation and deflation?
| Inflation | Deflation | |
|---|---|---|
| Overall price direction | A general rise in the price level over time. | A general decline in the price level over time. |
| What a household may notice | Money buys less if income does not keep pace with prices. | Some purchases may cost less, but falling prices across the economy can also weaken sales, income, and activity. |
| Effect on fixed nominal debt | Unexpected inflation can reduce the real value of a fixed debt, benefiting a borrower and disadvantaging a lender. | Falling prices and revenues can increase the real burden of a fixed nominal debt. |
| Policy challenge | Responding to inflation requires weighing price pressures against economic conditions and expectations. | Lowering interest rates may be constrained when rates are already near zero; falling demand can reinforce falling prices. |
Former Federal Reserve Board Governor Ben S. Bernanke put the key distinction this way in a November 21, 2002 speech: “Deflation is defined as a general decline in prices, with emphasis on the word ‘general.’” A drop in the price of a single product or sector—perhaps because productivity improved—is not economy-wide deflation. Bernanke, “Deflation” (2002)
What causes inflation and deflation?
Overall prices reflect the balance between demand for goods and services and the economy’s ability and cost to produce them. No single cause explains every episode: demand, supply costs, expectations, and policy can interact.
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Demand relative to productive capacity
When demand persistently grows faster than businesses can supply goods and services, firms may raise prices. When overall demand is persistently weak, businesses may cut prices to attract customers. If price cuts spread across the economy and continue, weak demand can contribute to deflation.
Supply costs and disruptions
Higher costs can push prices up even when demand is not unusually strong. Global commodity prices, exchange rates, taxes, and production costs can affect what firms pay and what consumers pay. The extent and duration of the effect depend on how businesses, workers, and customers respond.
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Expectations and monetary conditions
Expectations influence decisions. If households and firms anticipate sustained inflation, they may bring purchases forward, seek higher wages, or adjust prices and contracts. Those choices can affect actual price movements. Credible monetary policy can help keep expectations anchored. Long-lasting high inflation has often been associated with overly accommodative monetary conditions, but inflation should not be reduced to money supply alone: supply and demand conditions also matter. The appropriate policy response depends on the underlying causes and the wider economy. IMF: Inflation—Prices on the Rise
Independent reader supportYour contribution helps us test, update, and keep practical guides available for everyone.How do inflation and deflation affect households, borrowers, savers, and businesses?
Households and workers
When prices rise faster than nominal income, purchasing power falls: the same income buys less. The effect is uneven because households spend differently, incomes adjust at different times, and some contracts respond to price changes while others do not. Low, stable, predictable inflation is generally less disruptive to planning than volatile inflation, but it does not affect every household equally.
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Borrowers and lenders
Unexpected changes in the price level redistribute purchasing power when debts and other contracts are fixed in nominal terms. Inflation can reduce the real burden of a fixed-rate debt; deflation can increase it. The result depends on contract terms, timing, and whether incomes or asset values adjust along with prices.
Savers and firms
Inflation can erode the purchasing power of savings if the returns they earn do not keep pace with prices. For firms, unpredictable input costs and prices make budgeting, investment, and long-term contracts harder. Deflation can also hurt firms: if customers delay purchases expecting lower prices, sales and revenues may fall, putting further pressure on economic activity.
Why deflation can be damaging
Cheaper goods sound beneficial, but widespread falling prices can encourage buyers to wait, reducing current sales. Lower sales can mean lower business income and, in turn, weaker demand. At the same time, nominal debts do not automatically shrink when prices and revenues fall. Wage cuts can be difficult, and conventional interest-rate reductions become constrained as rates approach zero. These reinforcing pressures help explain why deflation is not automatically good news.
What do recent U.S. inflation figures show?
Every rate needs its reference period. The Federal Reserve’s July 2026 dashboard reported PCE inflation of 3.7 percent for July 2026. Separately, the Federal Reserve’s Monetary Policy Report submitted July 10, 2026, said PCE prices rose 4.1 percent over the 12 months ending in May 2026, compared with 2.5 percent over the prior-year comparison; core PCE inflation rose 3.4 percent over the 12 months ending in May. These are different reference periods, not competing readings for the same period.
The July 2026 report linked rising inflation to energy price surges after the start of conflict in the Middle East and signs that tariffs contributed to some consumer-goods price increases. It cautioned that tariff effects cannot be directly observed in official price statistics and depend on how consumers, firms, importers, and exporters respond. Federal Reserve Monetary Policy Report, July 10, 2026 · Federal Reserve Inflation Dashboard
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