What is Inflation?
How inflation is measured, what it does to purchasing power over time, how to use the Rule of 72, and why it matters for savings and investing.
What inflation means
Inflation is the rate at which prices across an economy rise over time. When inflation is 3%, something that cost $100 last year costs $103 this year. Your dollar buys less than it did before.
The flip side: if your savings account earns less than the inflation rate, the real value of your savings is shrinking even if the number in your account stays the same. A $10,000 savings account earning 0.5% APY during a 4% inflation year effectively lost 3.5% of its purchasing power.
How inflation is measured
The US Bureau of Labor Statistics (BLS) publishes two main inflation measures:
Tracks prices of a fixed "basket" of goods and services that typical households buy: food, housing, transportation, medical care, education, and recreation. This is the number most commonly cited in news coverage of inflation.
CPI excluding food and energy, which are highly volatile. The Federal Reserve watches core CPI more closely when setting interest rate policy, since food and energy swings can obscure the underlying inflation trend.
The Fed's preferred inflation measure. Slightly different methodology from CPI — it accounts for consumers substituting cheaper goods when prices rise, which makes it run a bit lower than CPI. The Fed targets 2% PCE inflation.
Historical US inflation rates
Average annual CPI inflation by decade:
1970s 7.4%/yr (oil shocks, high volatility) 1980s 5.6%/yr (Volcker-era tightening) 1990s 3.0%/yr 2000s 2.6%/yr 2010s 1.8%/yr (post-crisis low inflation) 2020–22 5.4%/yr (pandemic + supply chain disruptions) 2023–24 3.2%/yr (cooling but above 2% target)
The Fed's long-run target is 2% annual inflation. Historically, US inflation has averaged around 3–4% over the full 20th and 21st centuries combined.
The Rule of 72
Divide 72 by the inflation rate to estimate how many years it takes for prices to double — or for your money to lose half its purchasing power if it's not earning above that rate.
At 2% inflation: 72 ÷ 2 = 36 years to double prices At 3% inflation: 72 ÷ 3 = 24 years At 4% inflation: 72 ÷ 4 = 18 years At 7% inflation: 72 ÷ 7 ≈ 10 years At 10% inflation: 72 ÷ 10 = 7.2 years
At the US historical average of ~3%, prices roughly double every 24 years. A grocery cart that costs $200 today will cost ~$400 in 24 years.
Inflation and purchasing power: worked example
What $50,000 is worth in real purchasing power over time at 3% annual inflation:
Today $50,000 (baseline) 10 years $37,200 (lost $12,800 in real value) 20 years $27,700 (lost $22,300 in real value) 30 years $20,600 (lost $29,400 in real value)
Money sitting in a non-interest-bearing account (or earning below the inflation rate) loses real value every year. This is the primary reason long-term savings needs to be invested rather than held in cash.
Frequently asked questions
- What beats inflation?
- Historically, broad stock market index funds (US total market or S&P 500) have returned 7–10% annually before inflation and 5–7% after, well above the long-run inflation average of ~3%. Real estate, I-bonds (inflation-adjusted savings bonds), and TIPS (Treasury Inflation-Protected Securities) also provide inflation protection. Cash, standard savings accounts, and fixed annuities typically lose real value over time.
- Is some inflation good?
- Yes — mild inflation (around 2%) is considered healthy. It encourages spending and investment rather than hoarding cash (if prices will be higher tomorrow, there's incentive to buy today). Deflation (falling prices) sounds appealing but causes economic problems: businesses earn less, wages fall, debt burdens increase in real terms, and spending slows in a self-reinforcing cycle.
- How does inflation affect debt?
- Inflation helps borrowers and hurts lenders. If you have a fixed-rate mortgage at 3.5% and inflation runs at 5%, the real interest rate you're paying is negative — you're paying back your loan in dollars that are worth less than when you borrowed them. Conversely, holders of fixed-rate bonds lose purchasing power in high-inflation environments.
- Why do my personal expenses feel higher than the official CPI?
- CPI measures an average "basket" of goods across all households. Your personal inflation rate depends on your spending mix. If you rent in a high-cost city (shelter is the largest CPI component) or have significant healthcare or education costs, your actual experience of inflation may be significantly higher than the headline number.