Definition
Inflation is most commonly measured by the Consumer Price Index (CPI) or, in the US, the Personal Consumption Expenditures Price Index (PCE) which the Fed prefers. Sustained high inflation reduces the real value of cash, wages, and fixed-income coupons. It also generally leads central banks to raise interest rates, which typically pressures stock valuations (especially long-duration growth stocks). 'Core' inflation excludes volatile food and energy prices to reveal underlying trends. Structurally, inflation reflects demand-supply imbalance, monetary expansion, wage-price feedback loops, and supply-chain shocks. Hyperinflation (>50% monthly) is rare but historically devastating (Weimar, Zimbabwe, Venezuela).
Example
US CPI rose 9.1% year-over-year in June 2022 — the highest reading in 40 years. In response, the Fed hiked rates from near-zero to 5.25% over 16 months, and by 2024 CPI had cooled to the 3% range.
Frequently Asked Questions
Why do central banks target 2% inflation?
It's high enough to keep the economy running smoothly (avoiding deflation traps) but low enough to preserve purchasing power. The 2% target is a policy convention, not economic law.
How does inflation affect stocks?
Moderate inflation is generally neutral or positive for stocks (revenue grows with prices). High or volatile inflation is negative because it forces rate hikes and compresses valuation multiples, especially for long-duration growth companies.
What is stagflation?
The combination of high inflation and stagnant economic growth. Rare because inflation usually accompanies overheating, not slowdown. The 1970s US was the classic case.