What is Inflation?

In the 1960s, a gallon of milk cost around 95 cents. Today, in 2021, a gallon of milk costs around $2.50, a 163% increase. That’s inflation!

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Inflation is the general rise in the costs of goods and services over time. As inflation increases, purchasing power decreases. Essentially, $500 may buy you a new phone today, but in 20 years, that same $500 may not be enough to buy you a new phone.

Inflation is measured by the Consumer Price Index (CPI) which is reported monthly. The CPI measures the change in the prices of goods and services, known as a “market basket.” The market basket is a collection of typical purchases made by consumer such as haircuts, utility bills, and grocery items.

In April 2021, the CPI rose 4.2% from April 2020, the largest year over year increase since September 2008. Shortly after the CPI was released, the stock market fell dramatically as it stoked investor fears of high inflation.

High inflation negatively affects high-growth industries such as technology. As inflation increases, interest rates typically increase as well to slow the pace of inflation. Higher interest rates make borrowing costs high for companies and reduce the value of their future earnings.

High inflation positively affects businesses in the energy and consumer staples industries. As inflation increases, companies in these industries make more money due to higher prices for consumers.

Investors typically adjust their portfolios to prepare for inflation by investing in gold, oil, healthcare, and utility stocks while selling stock in high-growth companies.

Overall, inflation, if left unchecked, can result in damaging impacts to the economy as consumer purchasing power is reduced. In the long term, the Federal Reserve is targeting inflation rates of around 2%.