Inflation

Stock trading dictionary: meaning, example and how traders use it.

Last updated: October 17, 2026

Definition: Inflation is the rate at which the general level of prices for goods and services rises over time, reducing the purchasing power of money; in the US it is commonly measured by the Consumer Price Index (CPI) and the PCE price index.

How inflation works

When prices rise across the economy, each dollar buys less than before. If annual inflation is 3%, a basket that cost $100 last year costs about $103 today. Moderate, stable inflation is generally considered normal in a growing economy; the Federal Reserve targets 2% inflation over the longer run, measured by the PCE price index.

The opposite, a sustained fall in prices, is deflation. A combination of high inflation and stagnant growth is called stagflation.

Causes of inflation

  • Demand-pull: spending grows faster than the economy can produce goods and services, so sellers raise prices.
  • Cost-push: higher costs for inputs such as energy, wages, or raw materials are passed to customers.
  • Monetary factors: rapid growth in money and credit can push prices up over time.
  • Expectations: if businesses and workers expect higher prices, they set wages and prices accordingly, which can make inflation persist.

How inflation is measured

The Bureau of Labor Statistics publishes the CPI monthly, tracking prices for a representative basket of consumer purchases. "Core" measures exclude food and energy, which are volatile, to reveal the underlying trend. The Producer Price Index (PPI) tracks prices received by producers and can hint at future consumer price changes. Investors watch these releases closely because they influence interest rate expectations.

Example: inflation and real returns

Suppose an investor earns a 5% return on a bond in a year when inflation is 4%. The nominal return is 5%, but the real return, after inflation, is roughly 1%. If inflation rises to 6%, the same bond produces a real loss of about 1%, even though the account balance grew. Over long periods, this erosion compounds: at 3% annual inflation, prices roughly double in about 24 years.

How inflation affects stocks and bonds

Rising inflation usually leads the Federal Reserve to raise interest rates, which raises borrowing costs and lowers the present value of future earnings. That can pressure stock valuations, especially for growth companies whose profits lie far in the future. Fixed-rate bonds lose value as rates rise, since their payments are worth less in real terms.

Some assets have historically held up better: companies with pricing power, certain commodities, and real assets. Investors also use Treasury Inflation-Protected Securities (TIPS) and sometimes gold bullion as hedges, although none of these protects perfectly. Sector behavior varies; energy and materials companies may benefit from rising commodity prices, while utility stocks can be sensitive to higher rates. Inflation is a key consideration in long-term investment risk planning.

Frequently asked questions

Is inflation good or bad for stocks?

Moderate, stable inflation is usually manageable, but high or rising inflation tends to hurt valuations by pushing up interest rates and costs.

What is the difference between CPI and core CPI?

CPI covers a broad basket of consumer goods and services, while core CPI excludes food and energy prices to show the underlying trend.

What is a good inflation rate?

The Federal Reserve targets 2% annual inflation over the longer run, a level considered consistent with stable prices and maximum employment.

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For information only, not investment advice. See the disclaimer.