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What is Inflation?
Inflation is the rate at which the general level of prices rises over time, reducing purchasing power. The US Federal Reserve targets an average inflation rate of 2% per year. Historically, US inflation has averaged around 3–4% annually over the long term.
How Inflation Affects Savings
If your savings account earns 1% interest but inflation is 3%, your money is losing 2% of purchasing power each year in real terms. This is why investing — rather than just saving — is important for long-term wealth preservation.
Frequently Asked Questions
Inflation is the rate at which the general price level of goods and services rises over time, reducing purchasing power. A 3% inflation rate means $100 today buys what $97 bought a year ago. The US Federal Reserve targets 2% annual inflation.
The most common measure is the CPI (Consumer Price Index), which tracks prices of a 'basket' of goods and services: food, housing, transportation, medical care, etc. The PCE (Personal Consumption Expenditures) price index is the Fed's preferred measure.
US inflation peaked at 9.1% in June 2022 — the highest in 40 years — driven by supply chain disruptions, energy prices following the Russia-Ukraine war, and post-pandemic demand. It has since moderated significantly toward the Fed's 2% target.
Inflation erodes the real value of cash savings. Money in a savings account earning 1% while inflation runs at 3% effectively loses 2% of purchasing power per year. This is why investing in assets that outpace inflation (stocks, real estate, TIPS) is important for long-term wealth preservation.