What Is Inflation?

In the 1950s, you could buy many household items, like a loaf of bread, coffee, or toothpaste, for less than a dollar. Sounds like a deal these days, right? 

Most of us are probably familiar with the term “inflation,” which helps explain why the prices for goods and services have gone up over the years. 

In this article, we’ll go over how inflation works and what it means for your wallet. 

What is inflation?

Inflation happens when there's a broad increase in the prices of goods and services. If the buying power of a currency doesn’t increase accordingly, the currency loses value. With a devalued currency, you essentially have to spend more money to buy the same thing - a decrease in purchasing power. 

For instance, ever heard a parent or grandparent say that when they were a kid, they could buy a soda for a nickel? As you know, that’s not the case anymore. Buying a soda at a gas station these days will usually cost you at least $2. This is an example of how inflation can reduce purchasing power. You now need more dollars to buy the same soda. 

In this way, rising inflation can increase the general cost of living over time. And in the long run, that could slow economic growth since people can’t afford as much as they could previously. But not only do customers feel the pinch in times of rising inflation. Businesses can feel the squeeze, too. 

Say you’re the grocery store owner in the example above. Rising inflation can mean higher business operating expenses, as the cost of equipment, supplies, and utilities become more expensive. All of which can affect a business’s bottom line. Businesses could then, in turn, raise their prices to help offset those higher expenses. 

What is the inflation rate?

In the US, one popular way of measuring the inflation rate is using the Consumer Price Index (CPI). In simple terms, the index tracks how prices of a preselected basket of goods and services change over time.

The Consumer Price Index is maintained by the US Bureau of Labor Statistics, which provides updates each month. For instance, as of March 2025, the headline inflation rate stands at 2.4%, which means consumer prices have gone up approximately 2.4% over the last 12 months. 

See our monthly Consumer Dashboard under the Heard at Goldman Sachs column to get the latest insights on inflation and the economy.

Inflation can also be necessary because it helps counter the risk of deflation.

Deflation is essentially the opposite of inflation. It occurs when the overall price of goods, labor, and services goes down. So the purchasing power of currency goes up, and less money is required to buy the same things.

When deflation occurs, people might expect prices to drop, so they’re less willing to pay for something now if they think the price will be even lower in the near future. That expectation could decrease demand, which in turn could decrease output from producers and could lead to layoffs. Unemployment may then rise, leading to falling wages.

Bottom line? When it comes to inflation, it’s all about finding balance. While mild inflation can be helpful, a high rate of inflation can spell economic trouble, (e.g., rising prices and a slow economy).

Keeping inflation under control

In times of rising inflation, we often look to the Fed for help in keeping prices under control. For example, they may adjust the supply of money, so there’s less in circulation. One way to do this is by raising the federal funds rate, which can impact the interest rates that banks offer on their financial products, such as savings accounts, mortgages, and personal loans.  

4 tips for your finances in times of high inflation

While at the individual level we may not be able to do much about the rate of inflation, there are a few things we could do to help limit its impact on our finances:

1. Prioritize your spending, reducing nonessential purchases.
2. Pay down debt, especially loans with variable rates.
3. Continue to invest for the long term if you can.
4. Explore ways to increase your income; for example, consider asking for a raise or adding a side gig.