Inflation 101
The other half of the government debt story.
What inflation actually is
Inflation is a general rise in prices across the economy, which means each unit of currency buys less than it did before. A single price going up isn't inflation — gas getting more expensive because of a supply disruption, for example, is a relative price change. Inflation is when prices rise broadly, across most goods and services, at the same time.
How it's actually measured
The headline number you see in the news — CPI, the Consumer Price Index — comes from tracking the price of a fixed "basket" of goods and services that a typical household buys: groceries, rent, gasoline, health care, and so on. Statisticians price that same basket every month and compare it to the prior period. The percentage change is the inflation rate. "Core CPI" is the same idea with food and energy prices stripped out, since those two categories swing sharply for reasons that have nothing to do with broader inflation trends.
Why inflation and government debt are connected
Governments that borrow heavily have a strong incentive to want at least some inflation. Debt is normally fixed in nominal dollar terms — if a government owes $30 trillion, that number doesn't automatically shrink. But inflation erodes the real value of that debt over time, because the government is repaying old bonds with dollars that are worth less than the dollars it originally borrowed. This is one reason economists watch government debt levels and inflation trends side by side rather than in isolation.
The relationship runs the other way too: when investors expect a government to inflate its way out of debt rather than pay it down through spending cuts or tax increases, they demand higher bond yields to compensate — which shows up directly on the Bond Auctions and yield curve pages.
Breakeven inflation — the market's own forecast
One of the more useful numbers on the Feeds pages is "breakeven inflation." It's derived from comparing regular Treasury bond yields to inflation-protected Treasury bond yields (TIPS). The gap between the two is, roughly, what bond investors collectively expect inflation to average over that bond's life. It's not a perfect forecast, but it reflects real money being bet on the outcome, which makes it one of the more credible inflation forecasts available.
Why this affects you directly
- Wages that don't keep pace with inflation mean falling real purchasing power, even if the number on your paycheck is going up.
- Savings held in cash lose value in real terms during inflationary periods, which is part of why people look to assets like gold or other stores of value as a hedge.
- Interest rates set by central banks (see Central Banking) are adjusted largely in response to inflation, which in turn affects mortgage rates, credit card rates, and loan costs across the economy.
See also: the Glossary for quick definitions, and What Debt Means for You for how this all lands on your household budget specifically.