Inflation is the decline of a currency’s purchasing power over time. It is expressed as a percentage and tracks the rise of prices of a set basket of goods. It is the opposite of deflation, where a currency’s purchasing power increases over time. In the United States, we track two different “basket of goods” to determine inflation (or deflation): Consumer Price Index (CPI) and Producer Price Index (PPI).
The Consumer Price Index is based on about 94,000 price quotes from over 20,000 different stores and over 40,000 different rental housing units. The price tracked is the price paid by the consumer. The quotes are obtained monthly and are tallied up to create a month over month and then year over year calculation of inflation. Almost one third of the metric tracks the cost of shelter while the remaining two thirds tracks food, energy, transportation, medical care and other commodity costs.
The Producer Price Index tracks the measure of inflation at the wholesale level as opposed to the consumer level. These are the prices that manufacturers have to pay for the goods and services that they purchase in order to serve the consumer. PPI is calculated from over 100,000 quotes for goods and services used by over 25,000 producers in the United States. PPI is different from CPI in that it does not include the cost of shelter or imported goods. Therefore, PPI is a better metric to determine the rate of inflation for U.S. produced goods and services. PPI is seen as a “leading indicator” to CPI. When manufacturers see their input costs increase, they will pass those costs on to consumers which will increase CPI.
While it would seem that deflation would be better than inflation (I want my money to be worth more!), the preferred economic condition is for low, steady inflation. In periods of deflation, there are too many goods chasing too little money. This most often happens during periods of economic difficulty. Low, steady inflation occurs when people can afford their everyday consumables, while still being able to save for more expensive purchases.