🎯 In 30 seconds: Inflation means prices rise over time, so each dollar buys a little less. A little is normal: the Federal Reserve aims for 2% a year. The danger is quiet: cash left idle for years loses buying power even though the balance never goes down.
What the CPI measures
The Consumer Price Index, published monthly by the Bureau of Labor Statistics, tracks the average change in prices paid by consumers for a representative basket of goods and services. The headline version, CPI-U, covers urban households, which is over 90% of the US population.
The basket is grouped into eight major categories: food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services. When the news says “inflation was 3%,” it usually means the CPI was 3% higher than a year earlier.
Your personal inflation rate can differ. A renter who drives a lot feels rent and gas prices more than the average; a retiree may feel medical costs more.
How inflation erodes cash
Here is what $100 of buying power shrinks to if it sits in a 0% account:
| Inflation per year | After 10 years | After 20 years |
|---|---|---|
| 2% | $82 | $67 |
| 3% | $74 | $55 |
| 5% | $61 | $38 |
Worked example. You keep $10,000 in checking for 10 years and prices rise 3% a year. The balance still reads $10,000, but it buys what about $7,441 bought on day one (the math: $10,000 ÷ 1.03 raised to the 10th power, or $10,000 ÷ 1.344).
Rule of 72 shortcut. Divide 72 by the inflation rate to get the rough number of years until prices double (and cash loses half its buying power). At 3%, that is 72 ÷ 3 = 24 years. At 6%, just 12.
Real return. What you earn after inflation. A savings account paying 4% while inflation runs 3% has a real return of about 1%. One paying 0.5% is losing about 2.5% a year in buying power.
Why a little inflation is normal
The Federal Reserve targets 2% inflation over the longer run, measured by a related index called PCE (personal consumption expenditures). The Fed says 2% is most consistent with its two goals, maximum employment and stable prices, and that when people can expect inflation to stay low and stable, they can plan saving, borrowing and investing with more confidence.
When inflation runs well above target, the Fed usually raises interest rates to cool spending. That is why savings, CD and loan rates tend to move with inflation news. See Macro for today’s readings and Rates for current savings yields.
What tends to hold up
- I bonds (Series I savings bonds from TreasuryDirect): the rate tracks inflation. Up to $10,000 in electronic I bonds per Social Security number per calendar year. You must hold one at least 12 months, and cashing in before 5 years costs the last 3 months of interest.
- TIPS (Treasury Inflation-Protected Securities): the principal rises with the CPI, and interest is paid on the adjusted amount.
- High-yield savings and CDs: do not adjust to inflation directly, but their rates usually rise when the Fed raises rates.
- Stocks have historically outpaced inflation over long periods, with large swings along the way, so they suit money you will not need for years.
The Investing 101 section covers I bonds, TIPS and stocks in detail, including how they are taxed.