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Lesson 3 of 3

What Is Inflation?

EconomicsBeginner

Why the Same Basket Costs More Next Year

Inflation is a general rise in prices across the economy over time, which means each unit of currency buys a little less than it used to. It is usually measured by tracking the price of a fixed basket of common goods and services.

One product getting more expensive is not inflation by itself - that could just be higher demand for that specific thing. Inflation is about the broad price level moving, not any single price.

This is why salary negotiations reference cost-of-living increases, and why interest rate decisions react closely to inflation data - a raise that does not outpace inflation is a real-terms pay cut, even though the number on the paycheck went up.

How It's Actually Measured

The US Bureau of Labor Statistics tracks the Consumer Price Index (CPI) by pricing a fixed "basket" of goods and services - housing, food, energy, medical care, and more - every month, then comparing the total cost to a base period.

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CPI = (Cost of basket today / Cost of basket in base period) x 100

Annual inflation rate = (CPI now - CPI one year ago) / CPI one year ago x 100

Real numbers, not illustrative ones: the BLS reported headline CPI up 3.5% year-over-year in June 2026, a slowdown from May and the first pullback in the annual rate since January. "Core" inflation - which strips out volatile food and energy prices to see the underlying trend - was 2.6% year-over-year over the same period. Source: U.S. Bureau of Labor Statistics, CPI Summary, June 2026 (bls.gov/news.release/cpi.htm).

Monthly vs. Annual: Why They Can Tell Different Stories

That same June 2026 report showed the seasonally-adjusted CPI actually FALLING 0.4% from May to June - the largest one-month drop since April 2020 - driven mainly by a sharp pullback in energy prices. That is not the same thing as deflation. Deflation is prices falling on net versus a year ago; this was disinflation - the pace of annual price increases slowing down, while prices are still meaningfully higher than they were twelve months earlier. Mixing up "prices fell this month" with "inflation is now negative" is one of the most common misreadings of a CPI headline.