Inflation is the rate at which the general level of prices for goods and services rises and results in a decrease in the purchasing power of a country's currency.
There are two common measures of inflation: the consumer price index (CPI), calculated by the Bureau of Labor Statistics, and the personal consumption expenditures (PCE) price index from the Bureau of Economic Analysis. Though PCE has some very influential advocates—namely the Federal Open Markets Committee, which uses PCE to guide U.S. monetary policy—CPI is the more popular measure of inflation.
The Bureau of Labor Statistics began calculating CPI in 1919 when it published separate indexes for 32 cities. Two years later, the bureau began regularly publishing a national index representing average inflation in U.S. cities. CPI is expressed as either the month-over-month or year-over-year percent change in prices.
The Highest Inflation Rate in U.S History
Since the founding of the United States in 1776, the highest year-over-year inflation rate observed was 29.78% in 1778. In the period of time since the introduction of the CPI, the highest inflation rate observed was 20.49% in 1917.
Notably, both of these cases of rapid inflation coincide with major wars, the Revolutionary War and World War I.
Year-over-year inflation is calculated by subtracting the value of the CPI at the beginning of the year and subtracting the value at the end of the year. This result is divided by the value of the CPI at the beginning of the year and multiplied by 100. CPI data since its formal introduction as an index has been widely viewed as an accurate description of consumer prices in the United States. CPI data before 1913 is more problematic due to under-reporting, over-reporting, lack of data, and different reporting standards utilized.
The Federal Reserve and Inflation
Before the introduction of the U.S. Federal Reserve by the Federal Reserve Act in 1913, the U.S. economy grew in fits and starts. Severe shocks and panics followed periods of rapid inflation and growth in asset prices. Between 1775 and 1913, the United States experienced four separate periods of double-digit inflation.
The U.S. Federal Reserve is mandated to act to moderate inflation using policy measures where it will intervene in currency, debt, and equity markets to achieve this goal. Since the 1980s, the United States has enjoyed a lengthy period of low inflation, with U.S. Federal Reserve chairs often noting concerns regarding deflation rather than inflation. In the years following the 2008 financial crisis, the Fed has kept interest rates at historically low levels and initiated a bond-buying program (since discontinued) known as quantitative easing to help stimulate the economy—although not without its share of outspoken critics.