Deep Dive: What Is Inflation and How Is It Measured — CPI, PCE, and the Numbers That Move Markets

Inflation is the rate at which the general level of prices for goods and services rises over time, eroding the purchasing power of money. If inflation runs at 3% per year, a dollar today buys roughly 3% less a year from now. Over a decade, that compounds into a roughly 26% loss of purchasing power — which is why leaving cash idle in a savings account earning 1% effectively means losing money in real terms.

Economists distinguish between several types of inflation. Demand-pull inflation occurs when aggregate demand in the economy outpaces supply — too much money chasing too few goods. This is the classic overheating scenario, often seen during economic booms or when fiscal stimulus floods the system with spending power. Cost-push inflation happens when production costs rise — whether from higher raw material prices, supply chain disruptions, or wage increases — and businesses pass those costs on to consumers. The 2021-2023 inflation surge combined both: pandemic-era stimulus supercharged demand while global supply chains broke down simultaneously.

There is also monetary inflation, driven by central bank policy. When the Federal Reserve expands the money supply through quantitative easing or keeps interest rates too low for too long, more dollars circulate in the economy, bidding up prices. This is the mechanism behind Milton Friedman's famous dictum that "inflation is always and everywhere a monetary phenomenon." While modern economists debate whether this holds in all circumstances, the relationship between monetary policy and inflation remains central to how the Fed operates.

The United States relies on three primary inflation gauges, each with different methodologies and purposes. Understanding the differences matters because the Fed, markets, and policymakers sometimes respond to different signals from each measure.

The Consumer Price Index (CPI), published monthly by the Bureau of Labor Statistics, tracks the average price change for a fixed basket of roughly 80,000 goods and services purchased by urban consumers. It covers categories like housing (which makes up about 36% of the index), food, transportation, medical care, and apparel. The headline CPI includes all items, while Core CPI strips out volatile food and energy prices to reveal the underlying trend. As of January 2026, the CPI index level stands at 326.6, up from 319.7 in February 2025.

The Personal Consumption Expenditures (PCE) Price Index, published by the Bureau of Economic Analysis, is the Federal Reserve's preferred inflation measure. Unlike CPI, PCE uses a chain-weighted formula that accounts for consumers substituting cheaper alternatives when prices rise — if beef gets expensive, the PCE captures the shift to chicken, while CPI keeps measuring the original basket. PCE also has a broader scope, including spending by and on behalf of consumers (such as employer-paid health insurance). The Core PCE, excluding food and energy, rose from 124.6 in January 2025 to 127.9 in December 2025 — a year-over-year rate of approximately 2.7%, still above the Fed's 2% target.

The Producer Price Index (PPI) measures price changes at the wholesale level — what producers receive for their output before goods reach consumers. PPI acts as a leading indicator: when producers face higher costs, those increases typically flow through to consumer prices within weeks or months. As of December 2025, the PPI stood at 260.7, having been relatively stable since mid-2025, suggesting that the upstream pipeline pressure on consumer prices remains contained.

Inflation does not affect all asset classes equally, and understanding these dynamics is critical for portfolio construction.

Stocks have a complicated relationship with inflation. Moderate inflation (2-3%) is generally positive — it signals a healthy, growing economy where companies can raise prices and grow revenue. But high or accelerating inflation erodes corporate profit margins (unless companies can pass costs to consumers) and forces the Fed to raise rates, which compresses valuations. During the 2022 inflation shock, the S&P 500 fell roughly 19% as the Fed hiked rates from near zero to over 5%. Companies with strong pricing power — consumer staples, healthcare, and technology platforms with recurring revenue — tend to outperform during inflationary periods because they can maintain margins.

Bonds are the most directly affected asset class. Bond prices and yields move inversely, and inflation erodes the real return of fixed coupon payments. A 10-year Treasury yielding 4.08% with 2.4% inflation delivers a real return of roughly 1.7%. If inflation rises unexpectedly, existing bondholders lose purchasing power. This is why Treasury Inflation-Protected Securities (TIPS) exist — their principal adjusts with CPI, providing a guaranteed real return. The current 10-year Treasury yield of 4.08% reflects both real yield expectations and an inflation premium.

Gold and commodities are traditional inflation hedges. Gold has no cash flow and pays no yield, so its value is largely driven by inflation expectations and real interest rates. When real rates are low or negative (nominal rates minus inflation), the opportunity cost of holding gold drops, making it more attractive. Commodities more broadly tend to rise with inflation because they are the inputs whose price increases drive inflation in the first place. Real estate also benefits, as property values and rents typically rise with the general price level, providing a natural hedge.