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🌐 Macro Economics · Lesson 2 of 7 · 9 min

Inflation & CPI — The Silent Tax Everyone Pays

📊 In 2022 your savings account paid 0.5%. Prices rose 9.1%. Over that year, the money bought about 8.6% less than when you put it in — and the statement showed the same number the whole time. Inflation is the tax that never sends a bill. The CPI is how you catch it in the act.

💡 Key idea

CPI = inflation thermometer. 2% = Fed target. Above target = rate hikes. Real returns = nominal minus inflation.

🧠 Why it matters

CPI (Consumer Price Index) measures average price changes of a 'basket' of goods/services over time. Core CPI excludes food and energy (volatile). Fed targets 2% annual inflation. When CPI significantly exceeds 2%, the Fed raises rates to slow the economy and cool prices.

🌍 In the real world

💰 $100 in 1990 = about $240 in 2024 just to stay even with inflation. If you kept $100 in a mattress since 1990, you have about $42 in real value. The S&P 500 over the same period, dividends reinvested: $100 → roughly $3,500. Inflation is slow, constant, and invisible until it's devastating.

📌 Takeaways

  • CPI basket: housing, food, energy, services
  • Core CPI strips volatile food/energy
  • Real return = nominal return minus inflation rate

📖 Terms in this lesson

Inflation: Prices rising over time, so the same money buys less than it used to.

CPI: Consumer price index: the official measure of inflation, tracking the price of a basket of everyday things.

✅ Test yourself

The Fed's inflation target is:
  1. 0% — zero inflation is ideal
  2. 2% annually
  3. 5% annually
  4. Whatever Congress decides

Answer: B · 2% annually

The Fed targets 2% annual inflation — enough to encourage spending (deflation is actually worse) but low enough to preserve purchasing power.

What's the difference between CPI and 'Core CPI'?
  1. Core CPI is always higher
  2. Core CPI excludes food and energy — too volatile for policy decisions
  3. They're the same
  4. Core CPI only measures tech prices

Answer: B · Core CPI excludes food and energy — too volatile for policy decisions

Food and energy prices spike on supply shocks. Core CPI strips them out to show the underlying trend. (The Fed's preferred gauge is a close cousin, core PCE, which it watches for the same reason.)

Your savings earns 2%. Inflation is 5%. Your money is:
  1. Growing in real terms
  2. Losing 3% of real purchasing power annually
  3. Safe because the bank guarantees it
  4. Beating inflation by 2%

Answer: B · Losing 3% of real purchasing power annually

Real return = nominal minus inflation. 2% - 5% = -3% real return. Your dollars are safe but buy less each year. This is why investing matters.

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