How does inflation work? Inflation drives prices for goods and services higher and results in lower purchasing power, which in turn stems economic progress. On the flip side we have deflation which results in lower prices and higher purchasing power but it also results in weaker economic conditions. This is why the Federal Reserve targets the happy medium inflation rate at 2%.
While the Federal Reserve has targeted an inflation rate of 2%, given that they believe that is the equilibrium rate to maintain price stability and maximum employment levels, the most recent readings have lagged below the target. The most recent reading that was released in October came in at 1.5%.
So if prices haven’t been increasing at the desired rate, why do we feel like our dollar isn’t going as far? Looking at the Consumer Price Index, which tracks a basket of goods, shows that prices have increased roughly 54% over the past 20 years. However, some things have increased much more rapidly than others. The picture below shows that the largest increases over the past 20 years have come from textbooks, tuition, childcare and healthcare. The largest decrease in prices have come from consumables rather than services.
