If it feels like your dollar doesn’t go quite as far as it used to, you aren’t imagining it.
The reason is inflation, which describes the gradual rise in prices and slow decline in purchasing power of your money over time. Here’s how to understand inflation, plus a look at the steps that you can take to protect the value of your money.
How Does Inflation Work?
Inflation occurs when prices rise across the economy, decreasing the purchasing power of your money. In 1980, for example, a movie ticket cost on average $2.89. By 2025, the average price of a movie ticket rose to $16.08.
Don’t think of inflation in terms of higher prices for just one item or service, however. Inflation refers to the broad increase in prices across a sector or an industry, like the automotive or energy business—and ultimately a country’s entire economy.
The chief measures of U.S. inflation are the Consumer Price Index (CPI), the Producer Price Index (PPI) and the Personal Consumption Expenditures Price Index (PCE), all of which use varying measures to track the change in prices consumers pay and producers receive in industries across the whole American economy.
Though it can be frustrating to think about your dollars losing value, most economists consider a small amount of inflation a sign of a healthy economy. A moderate inflation rate encourages you to spend or invest your money today, rather than stuff it under your mattress and watch its value diminish.
Inflation can become a destructive force in an economy if it is allowed to get out of hand and rise dramatically.
What Is Deflation?
When prices decline across a sector of the economy or throughout the entire economy, it’s called deflation. While it might seem nice that you can buy more for less tomorrow, economists warn that deflation can be even more dangerous for an economy than unchecked inflation.
When deflation takes hold, consumers delay purchases in the present as they wait for prices to decline even further in the future. If left unchecked, deflation can diminish or freeze economic growth, which in turn decimates wages and paralyzes an economy.
Extreme Inflation: Hyperinflation & Stagflation
When inflation isn’t kept in check, it’s commonly known as hyperinflation or stagflation. These terms describe out-of-control inflation that cripples consumers’ purchasing power and economies.
What Is Hyperinflation?
Hyperinflation occurs when inflation rises rapidly and the value of the currency of the country tumbles rapidly.
Economists define hyperinflation as taking place when prices rise by at least 50% each month. Though rare, past instances of hyperinflation have taken place during civil unrest, during wartime or when regimes have been taken over, rendering currency effectively worthless.
Perhaps the best-known example of hyperinflation took place in Weimar Germany, in the early 1920s.
What Is Stagflation?
Stagflation occurs when inflation remains high, but a country’s economy is stagnant, and its unemployment is rising. Usually, when unemployment increases, consumer demand decreases as people watch their spending more closely. This decrease in demand lowers prices, helping to recalibrate your purchasing power.
When stagflation happens, however, prices remain high even as consumer spending decreases, making it increasingly expensive to buy the same goods.
We don’t have to look abroad to find examples, as the U.S. experienced stagflation in the mid to late 1970s. High prices from the Organization of the Petroleum Exporting Countries (OPEC) oil embargoes in the 1970s drove inflation higher as a recession lowered gross domestic product (GDP) and increased unemployment.
What Causes Inflation?
The gradually rising prices associated with inflation can be caused in two main ways: demand-pull inflation and cost-push inflation. Both come back to the fundamental economic principles of supply and demand.
Demand-Pull Inflation
Demand-pull inflation is when demand for goods or services increases, but supply remains the same, pulling up prices.
In a healthy economy, people and companies increasingly make more money. This growing purchasing power allows consumers to buy more than they could before. In turn, this increases competition for existing goods and raises prices while companies attempt to ramp up production. On a smaller scale, demand-pull inflation can be caused by sudden popularity of certain products.
For example, at the start of the Covid-19 pandemic, the increase in demand for indoor, socially distant activities combined with the highly anticipated release of Animal Crossing: New Horizons saw the price of the Nintendo Switch gaming system almost double on some secondary markets. Because Nintendo could not increase production, due to factory production halts from Covid-19, Nintendo could not raise its supply to meet rising consumer demand, resulting in increasingly higher prices.
Cost-Push Inflation
Cost-push inflation is when the supply of goods or services is limited in some way. But demand remains the same, pushing up prices. Usually, some sort of external event, like a natural disaster, hinders companies’ abilities to produce enough of certain goods to keep up with consumer demand. This allows them to raise prices, resulting in inflation.
For example, think about oil prices. You—and pretty much everyone else—need a certain amount of gas to fuel your car. When international treaties or disasters drastically reduce the oil supply, gas prices rise because demand remains relatively stable even as supply shrinks.
How Is Inflation Measured?
The U.S. inflation rate is measured by the CPI, PPI and PCE indexes. Because no single index captures the full range of price changes in the U.S. economy, economists must consider these multiple indexes to get a comprehensive picture of the rate of inflation.
The basic formula to calculate the inflation rate is as follows:
Consumer Price Index (CPI)
The U.S. Bureau of Labor Statistics calculates monthly based on the changes in prices consumers pay for goods and services. The CPI uses a “basket of goods” approach, meaning it tracks changes in the costs of eight major categories people spend money on: food and beverages, housing, apparel, transportation, education and communication, recreation, medical care, and other goods and services.
Many consider CPI as the benchmark for measuring inflation in the U.S.
CPI is especially important because it is used to calculate cost of living increases for Social Security payments and for many companies’ annual raises. It is also used to adjust the rates on some inflation-protected securities, like Treasury Inflation-Protected Securities (TIPS).
Producer Price Index (PPI)
Also published by the Bureau of Labor Statistics, PPI tracks the changes in prices that companies receive for the goods and services they sell each month. Costs can rise when producers face an increase in tariffs, higher oil and gas prices to transport their items, or other issues, such as the impact of a long-lasting pandemic or environmental changes, like a rise in hurricanes, wildfires or flooding.
The PPI plays an important role in business contracts. Businesses that enter long-term contracts with suppliers frequently use the PPI to automatically adjust the rate they pay for raw goods and services over time. Otherwise, suppliers would lock themselves into yearslong contracts at rates that might lose their purchasing power over the long term.
Personal Consumption Expenditures Price Index (PCE)
Published by the Bureau of Economic Analysis (BEA), PCE tracks how much consumers pay for goods and services in the economy.
PCE considers a broader range of consumer expenditures than CPI, like healthcare spending. It also updates the basket of goods it uses for calculations based on what consumers are spending money on each month, rather than limiting data to a fixed set of goods.
PCE is an especially important measure because it’s the Federal Reserve’s preferred measure of inflation when making monetary decisions, such as rate hikes or cuts.
Inflation and the Fed
The Federal Reserve is the central bank of the U.S., and the Fed—like central banks around the world—is tasked with maintaining a stable rate of inflation.
The Federal Open Markets Committee (FOMC) has determined that an inflation rate around 2% is optimal for employment and price stability.
This level of inflation gives the FOMC scope to jump-start the economy during downturns by decreasing interest rates, which makes borrowing cheaper and helps boost consumption. Lower interest rates reduce costs for businesses and consumers to borrow money, stimulating the economy. Lower interest rates also mean individuals earn less on their savings, encouraging them to spend. But all this extra demand can push up inflation.
How Does Inflation Impact the Stock Market?
Some inflation can be a sign of a healthy, growing economy, but when inflation rises higher than expected or becomes unpredictable, it tends to hurt investors and businesses alike.
When inflation rises sharply, companies face higher costs for materials, labor and transportation. If they can’t raise prices to match those costs, their profit margins will shrink.
Inflation also tends to influence the Federal Reserve’s decisions. When prices rise too quickly, the Fed has been known to increase interest rates to preserve the economy. Higher rates make borrowing more expensive for businesses and consumers, which can slow growth.
However, not all industries react the same way. Energy, utilities and consumer staples, for instance, can often pass increased costs onto consumers to remain profitable. Meanwhile, growth stocks and tech companies may struggle.
What Investments Beat Inflation?
Even a moderate rate of inflation means that money held as cash or in low-APY bank accounts will lose purchasing power over time. You can beat inflation and boost your purchasing power by investing your money in certain assets.
To overcome inflation, “A good portfolio could include shorter-maturity bonds, a bit of TIPS, commodities and gold, and ideally a share of real assets that generate income, adjusting exposures as inflation expectations change, rather than thinking one static mix will work,” says Alex Tsepaev, chief strategy officer at B2Prime Group, a global financial services provider for professional and institutional clients.
Beat Inflation with Stocks
Investing in the stock market is one way to potentially beat inflation. While individual stock prices may fall and companies may go out of business, broader stock market indexes rise over the long run, beating inflation.
From 1937 to 2025, the S&P 500, which tracks the performance of 500 of the largest companies in the U.S., generated an average annual return of just over 12%, according to LSEG Datastream and Yardeni Research. This is a long-term average—in some years, the S&P 500 had lower or even negative returns.
Investing in individual stocks offers no guarantees, but a well-diversified investment in a broad market index fund can grow wealth over decades and beat inflation.
Beat Inflation with Bonds
Bonds on average offer lower returns than stocks, but they can also regularly beat inflation. Risk adverse investors or those approaching or in retirement may seek out the more consistent returns of investments in bonds and bond funds to beat inflation.
Treasury Inflation-Protected Security (TIPS)
Treasury Inflation-Protected Securities (TIPS) are a special class of U.S. Treasury bonds specifically designed to protect investors from inflation.
TIPS automatically adjust the value of your investment based on changes to CPI, meaning the value of your bond rises with inflation. TIPS pay interest over the five-, 10-, or 30-year life of the bond.
Can You Beat Inflation With Gold?
Many investors consider gold as the ultimate inflation hedge, although the debate over this proposition is far from settled.
The price of gold can fluctuate over time and is impacted by movements of global currencies. Monetary policy choices made by the Fed and other central banks, not to mention erratic supply and demand.
Investing in gold also comes with its own unique set of challenges. If you buy gold, you have to find a secure location or custodian to store it, which comes with costs of its own. If you sell gold after holding it for a year or more, it’s subject to higher long-term capital gains tax rates than stocks and bonds.
