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Economics 101: All About Inflation
- Jade Chapman/Brien L. Smith CFP®
- Jun 24, 2025
- 3 min read
Question: “What is inflation?”
Inflation, simply put, is the rate at which the general level of prices for goods and services rises over time.
It is inversely related to purchasing power, meaning that when inflation rises, each dollar buys less than before.
For example, one dollar in the 1950s could buy more products than it would now, showing that the currency had more purchasing power back then.
Moderate inflation indicates a healthy economy, reflecting growing demand, rising wages, and increased investments.
The Federal Reserve targets a 2% annual inflation rate to encourage spending, investment, full employment, and financial stability, while also maintaining financial stability.
Inflation that is too low or negative is known as deflation, which is dangerous as it reflects weak demand, falling wages, and higher unemployment.
Deflation differs from disinflation, which is where prices rise at a slower pace (e.g. the inflation rate drops from 6% to 3%).
Question: “How is inflation measured?”
The most common tool to measure inflation in the U.S. is the Consumer Price Index (CPI), which tracks the average change in prices paid by urban consumers for a basket of goods and services.
Question: “What causes inflation?”
Inflation can be caused by several factors:
Demand-pull inflation: When people spend more, demand increases, leading to higher prices.
Cost-push inflation: When production costs, such as wages or raw materials, rise, businesses increase prices to maintain profits.
Wage-price spiral: When workers expect higher inflation, they demand higher wages, leading businesses to raise prices.
Excess money supply: When central banks print too much money or keep interest rates too low, there is more money in the economy, driving prices up.
Supply problems: Shortages or disruptions (e.g., oil, food) can push prices up.
Question: “What does inflation mean for investment?”
Central banks use interest rates to manage inflation and investment. When inflation is high, they often raise rates to cool the economy, discouraging borrowing and investment. When inflation is low, they may lower rates to encourage investment and stimulate growth.
Question: “How would Trump’s One Big Beautiful Bill Act impact inflation?”
The One Big Beautiful Bill Act, passed by the U.S. House of Representatives on May 22, 2025, is central to President Donald Trump's economic agenda and is under consideration in the Senate.
Potential Upsides: Boosts economic activity through tax cuts and increased government spending; increases take-home pay by eliminating taxes on tips and overtime; supports industries like defense, construction, and border infrastructure; provides tax relief for residents in high-tax states via a higher SALT deduction cap; encourages work and productivity by reducing tax burdens on earned income.
Potential Downsides: May raise inflation due to higher demand and government spending; adds $3.8 trillion to the national debt, possibly increasing interest rates; cuts to healthcare and nutrition programs could affect low-income groups; tariffs and clean energy rollbacks might raise costs and hurt green investment; long-term economic risks if debt grows faster than GDP.
Question: “What impact do tariffs have on inflation?”
Tariffs can raise import prices, making goods from other countries more expensive; they can increase production costs for U.S. companies that rely on imported materials; they can increase retail prices for consumers as production costs are raised; they can reduce competition, as fewer cheap imports can allow domestic producers to raise prices; and they can disrupt supply chains, with delays and shortages adding to price pressures.
Inflation plays a powerful role in shaping the U.S. economy, influencing everything from consumer spending to government policy. By understanding its causes, how it’s measured, and its broader economic effects, individuals and investors can make more informed financial decisions. Staying informed about these dynamics is key to navigating the economic landscape with clarity and confidence.
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