Economy and interest rates · updated October 21, 2026
What is inflation and how is it calculated
Inflation shows by what percentage prices rose, on average, over a year. With 5% inflation, what cost $100 last year costs $105 now. Cash kept under the mattress buys less every year.
Inflation formula
- CPI
- The consumer price index: the cost of a basket of what an ordinary household buys (food, rent, energy, transport, services).
- 12 months ago
- The same month last year, so seasonal swings do not distort the result.
Worked example
A family's shopping basket cost $100 a year ago. Today, the same items cost $105.
$10,000 now buys what $9,524 bought last year. To avoid losing out, your money has to earn at least 5% a year.
How to read inflation
The Federal Reserve and the European Central Bank both target 2% a year. In 2022, US inflation peaked at 9.1%, the highest in about 40 years, and euro area inflation passed 10%.
When inflation can fool you
The average hides differences: if you spend a lot on food and energy, your personal inflation can be far above the official figure. Core inflation: without energy and food, it moves more slowly and shows the trend better.
Related terms
Learn it in the Academy
Questions about inflation
How do I protect myself from inflation?
Your money has to earn more than inflation: savings or government bonds paying more than inflation, and stocks and funds over the long run. Cash kept at home loses value every year.
Who calculates inflation?
National statistics offices, every month. In the US it is the Bureau of Labor Statistics; in the EU, Eurostat publishes a comparable measure for all member states, the HICP.
Why is low inflation good, but not zero?
2% inflation gives wages and prices room to adjust and keeps deflation away, which is much harder to stop.
These explanations are for information only. They are not a recommendation to buy or sell.
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