Inflation Rate

The inflation rate is the increase in prices for a basket of goods and services expressed on a yearly basis. Put simply, if the basket costs $100 in year 1 and $104 in year 2, the inflation rate is 4%. Perhaps the most common measure of the inflation rate is the monthly Consumer Price Index (CPI), which is based on a survey of tens of thousands of items Americans commonly purchase. Other important measures of the inflation rate are the Producer Price Index and the GDP Price Deflator. The inflation rate has enormous consequences for the economy and, by extension, investors. A rising inflation rate prompts the Federal Reserve Board to push up interest rates to slow the economy; a declining inflation rate encourages the Fed to loosen monetary policy to stimulate demand. Bond prices move inversely with interest rates; thus a lower inflation rate increases bond prices, a higher rate reduces them. The relationship between stocks and the inflation rate is less fixed, but a modest inflation rate usually provides a good environment for stock prices.

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