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What Is Inflation? How It Erodes Purchasing Power
Published May 31, 2026
What Is Inflation? How It Erodes Purchasing Power Over Time
Inflation is the rate at which prices for goods and services rise over time — and equivalently, the rate at which the purchasing power of money falls. If inflation runs at 3% per year, something that costs $100 today will cost $103 in a year and roughly $180 in 20 years.
How Inflation Is Measured
Two indexes dominate:
| Index | What it tracks | Who uses it |
|---|---|---|
| CPI-U (Consumer Price Index) | Basket of goods and services for urban consumers | US government, Social Security adjustments |
| PCE (Personal Consumption Expenditures) | Broader spending patterns, chain-weighted | Federal Reserve's preferred measure |
| Core CPI / Core PCE | Excludes food and energy (volatile) | Policy analysis, stripping noise |
CPI is the most commonly cited. When someone says "inflation is 4%," they almost always mean CPI-U year-over-year change.
The Purchasing Power Formula
To find what today's dollars are worth in the future — or what past dollars are worth today:
Future value = Present value × (1 + inflation rate)^years
Present value = Future value ÷ (1 + inflation rate)^years
Example: You have $50,000 in savings. At 3% annual inflation:
- In 10 years it buys what $37,200 buys today.
- In 20 years it buys what $27,700 buys today.
The money hasn't gone anywhere — but its purchasing power has nearly halved.
Use the Inflation Calculator to enter any amount and see its real value across any number of years.
Historical US Inflation Rates
| Decade | Average annual CPI |
|---|---|
| 1970s | ~7.4% (energy shocks) |
| 1980s | ~5.6% (disinflation) |
| 1990s | ~3.0% |
| 2000s | ~2.6% |
| 2010s | ~1.8% |
| 2020–2022 | ~5.4% (post-pandemic spike) |
| 2023–2024 | ~3.2% (cooling) |
The long-run US average is roughly 3%. Planning tools typically use 2–3% as a base assumption.
Why Inflation Matters for Savings and Investments
A savings account earning 1% APY when inflation is 4% has a real return of −3%. You're earning nominal interest but losing real purchasing power every year.
Real return = Nominal return − Inflation rate
This is why long-term financial planning uses real returns, not nominal ones. A retirement calculator that ignores inflation systematically overstates future wealth. The Retirement Calculator lets you set an expected inflation rate to model the gap.
How Inflation Affects Different Assets
| Asset | Inflation behaviour |
|---|---|
| Cash / savings account | Loses real value if yield < inflation |
| Bonds (fixed rate) | Real return falls as inflation rises |
| TIPS / I-bonds | Principal adjusts with CPI — explicit inflation hedge |
| Equities | Historically outpace inflation over long periods |
| Real estate | Often tracks or exceeds CPI; rent follows prices |
| Commodities | Historically correlated with inflation spikes |
Inflation and Your Savings Goal
If you're saving toward a target — a house down payment, an emergency fund, a college fund — you need to inflate that target forward, not just divide by months. A $30,000 goal today becomes a ~$40,300 goal in 10 years at 3% inflation.
The Savings Goal Calculator accounts for this when you set your target date.
What the Inflation Calculator Shows
The Inflation Calculator answers three questions:
- Future equivalent — what a today's dollar amount costs in N years at a given rate.
- Past equivalent — what a historical amount equals in today's money.
- Rate needed — what inflation rate connects two amounts over a period.
It also shows the year-by-year real value erosion so you can see the compounding effect visually rather than as a single number.