The inflation rate measures how much prices for a set of goods and services have risen over a specified period of time. It can be a very broad measure, such as the overall increase in price levels, or it can be more focused, like tracking the cost of a specific basket of consumer goods that represents 90% of the US economy. The CPI is most often used by government agencies and private data providers to track inflation and help consumers and businesses plan for the future. The CPI also provides the basis for the annual cost-of-living adjustments that many recipients of Social Security and other transfer payments receive to keep their spending power intact.
The primary reason to pay attention to inflation is that it reduces the purchasing power of a currency. When the general price level rises, each monetary unit can buy fewer goods and services in aggregate. This effect is most damaging to those segments of the population who rely on fixed incomes, such as retirees and those receiving pension or disability benefits. It is also harmful to investors who seek to grow their long-term purchasing power by putting money into stocks or other assets.
However, not all prices and wages respond to the same degree to the new supply of money in the economy. Some, such as the prices of traded commodities, change every day; others, such as wages established by contract, take longer to adjust. This uneven rate of rising prices is the root cause of inflation, and it erodes real wages and rates of return. The most damaging form of inflation is galloping inflation, which occurs when prices skyrocket and the value of real wages erodes faster than the general price level.