The inflation rate is the percentage that describes how quickly prices are rising, reducing the purchasing power of money. Statistical agencies track price changes in a broad range of products and services that people use to live, typically by tracking the value of a basket of goods and services and comparing it over time. In the US, the Bureau of Labor Statistics publishes a Consumer Price Index (CPI) that monitors the cost of items urban consumers buy out of pocket and reports it on a monthly basis. The Personal Consumption Expenditures (PCE) price index, also published by the BLS, takes into account a broader range of spending and is weighted by data from business surveys.
Consumers care about inflation because it can raise their costs for food, utilities, and other items. Businesses also watch the inflation rate, as it affects the cost of raw materials and what they pay workers. A low, steady, and predictable level of inflation is generally considered good for an economy as it signals growth and healthy demand for goods and services.
Investments in diversified asset classes can provide a hedge against inflation, as higher interest rates can offset lower commodity prices. The volatility of commodity prices can mean that a portfolio’s exposure to this risk may increase in periods of higher inflation. As a result, a portfolio’s allocation to stocks and nominal fixed income can potentially have a positive correlation with the overall inflation rate, challenging traditional diversification strategies.