A:

Inflation is a term used by economists to define broad increases in prices. Inflation is the rate at which the price of goods and services in an economy increases. Inflation also can be defined as the rate at which purchasing power declines. For example, if inflation is at 5% and you currently spend $100 per week on groceries, the following year you would need to spend $105 for the same amount of food.

Economic policy makers like the Federal Reserve maintain constant vigilance for signs of inflation. Policy makers do not want an inflation psychology to settle into the minds of consumers. In other words, policy makers do not want consumers to assume that prices always will go. Such beliefs lead to things like employees asking employers for higher wages to cover the increased costs of living, which strains employers and, therefore, the general economy.

Stagflation is a term used by economists to define an economy that has inflation, a slow or stagnant economic growth rate and a relatively high unemployment rate. Economic policy makers across the globe try to avoid stagflation at all costs. With stagflation, a country's citizens are affected by high rates of inflation and unemployment. High unemployment rates further contribute to the slowdown of a country's economy, causing the economic growth rate to fluctuate no more than a single percentage point above or below a zero growth rate.

Stagflation was experienced globally by many countries during the 1970s when world oil prices rose sharply, leading to the birth of the Misery Index. The Misery Index, or the total of the inflation rate and the unemployment rate combined, functions as a rough gauge of how badly people feel during times of stagflation. The term was used often during the 1980 U.S. presidential race.

(To learn more about inflation and stagflation, see Stagflation, 1970s Style and Inflation: What Is Inflation?)

This question was answered by Tony D'Altorio.

RELATED FAQS
  1. Why are P/E ratios generally higher during times of low inflation?

    Inflation affects equity prices in several ways. Most importantly, investors are willing to pay less for a certain level ... Read Answer >>
  2. What does the current cost of living compare to 20 years ago?

    Find out how inflation has affected the dollar since 1994, and how the cost of living has changed above and beyond what can ... Read Answer >>
  3. What is the relationship between inflation and interest rates?

    Inflation and interest rates are linked, and frequently referenced in macroeconomics. Inflation refers to the rate at which ... Read Answer >>
  4. What's the lowest year-over-year inflation rate in the history of the U.S.?

    Learn about years with the lowest year-over-inflation in U.S. history. Read about how inflation is calculated using the consumer ... Read Answer >>
  5. When is the best time to buy a fixed income security?

    Determine the optimal time to buy fixed income securities; the key is inflation and interest rates falling, which makes the ... Read Answer >>
  6. How does inflation affect the exchange rate between two nations?

    Understand how inflation can affect foreign exchange rates of a currency and how it is just one of many economic factors ... Read Answer >>
Related Articles
  1. Economics

    An Explanation Of Stagflation

    Find out how stagflation is measured, what factors contribute to it and how to protect your finances.
  2. Savings

    Inflation for Dummies

    Inflation may seem like a straightforward concept, but it is more complex than it appears. We examine its varieties and causes.
  3. Retirement

    Inflation: Conclusion

    After reading this tutorial, you should have some insight into inflation and its effects. For starters, you now know that inflation isn't intrinsically good or bad. Like so many things in life, ...
  4. Investing Basics

    Inflation's Impact On Stock Returns

    When stocks are divided into growth and value categories, the evidence is clear that value stocks perform better in periods of high inflation, and growth stocks perform better during periods ...
  5. Economics

    Inflation And Economic Recovery

    Inflation impacts the costs of every facet of the economy. Discover how it can help or hinder the economic recovery.
  6. Fundamental Analysis

    How Inflation Affects Your Cash Savings

    Prices tend to rise over time and this inflation can cut into the value of your savings. Here are some ways you can manage the situation.
  7. Economics

    Macroeconomics: Inflation

    By Stephen Simpson Inflation is a key concept in macroeconomics, and a major concern for government policymakers, companies, workers and investors. Inflation refers to a broad increase in prices ...
  8. Economics

    Examining The Phillips Curve

    This model depicts an inverse relationship between unemployment and wage inflation, but is it accurate?
  9. Savings

    How Inflation Affects Your Net Worth

    When calculating your net worth, don't forget to take inflation into account.
  10. Options & Futures

    Fight Back Against Inflation

    Inflation is often a consequence of economic recovery. Here's how you can protect your financial portfolio.
RELATED TERMS
  1. Inflation Targeting

    A central banking policy that revolves around meeting preset, ...
  2. Inflation Trade

    A method of investing that seeks to profit from an overall increase ...
  3. Inflation

    The rate at which the general level of prices for goods and services ...
  4. Base Effect

    The consequence of abnormally high or low levels of inflation ...
  5. Core Inflation

    A measure of inflation that excludes certain items that face ...
  6. Inflation Swap

    A derivative used to transfer inflation risk from one party to ...
Hot Definitions
  1. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  2. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  3. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  4. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  5. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  6. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
Trading Center