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Definition of Inflation

Inflation Image 1


A sustained increase in the general price level. The inflation rate is the percentage rate of change in the price level.


Rate at which prices as a whole are increasing.


The rate at which the general level of prices for goods and services is rising.

Related Terms:

Inflation risk

Also called purchasing-power risk, the risk that changes in the real return the investor will
realize after adjusting for inflation will be negative.

Inflation uncertainty

The fact that future inflation rates are not known. It is a possible contributing factor to
the makeup of the term structure of interest rates.

Inflation-escalator clause

A clause in a contract providing for increases or decreases in inflation based on
fluctuations in the cost of living, production costs, and so forth.

Cost-Push Inflation

inflation whose initial cause is cost increases rather than excess demand. See also demand-pull inflation.

Demand-Pull Inflation

inflation whose initial cause is excess demand rather than cost increases. See also cost-push inflation.

Inflation Image 2


A reduction in the rate of inflation.


Extremely high inflation.

Inflation Tax

The loss in purchasing power due to inflation eroding the real value of financial assets such as cash.

After-tax real rate of return

Money after-tax rate of return minus the inflation rate.

Consumer Price Index (CPI)

The CPI, as it is called, measures the prices of consumer goods and services and is a
measure of the pace of U.S. inflation. The U.S.Department of Labor publishes the CPI very month.

Fisher effect

A theory that nominal interest rates in two or more countries should be equal to the required real
rate of return to investors plus compensation for the expected amount of inflation in each country.


In name only. Differences in compounding cause the nominal rate to differ from the effective
interest rate. inflation causes the purchasing power of money to differ from one time to another.

Nominal interest rate

The interest rate unadjusted for inflation.

Purchasing-power risk

Related: inflation risk

Inflation Image 3

Real exchange rates

Exchange rates that have been adjusted for the inflation differential between two countries.

Real interest rate

The rate of interest excluding the effect of inflation; that is, the rate that is earned in terms
of constant-purchasing-power dollars. Interest rate expressed in terms of real goods, i.e. nominal interest rate
adjusted for inflation.

Tilted portfolio

An indexing strategy that is linked to active management through the emphasis of a
particular industry sector, selected performance factors such as earnings momentum, dividend yield, priceearnings
ratio, or selected economic factors such as interest rates and inflation.

Real Interest Rate

The rate of interest paid on an investment adjusted for inflation

international Fisher effect

Theory that real interest rates in all countries should be equal, with differences in nominal rates reflecting differences in expected inflation.

purchasing power parity (PPP)

Theory that the cost of living in different countries is equal, and exchange rates adjust to offset inflation differentials across countries.

Accelerationist Hypothesis

Belief that an effort to keep unemployment below its natural rate results in an accelerating inflation.

Cold-Turkey Policy

Decreasing inflation by immediately decreasing the money growth rate to a new, low rate. Contrast with gradualism.

Consumer Price Index (CPI)

An index calculated by tracking the cost of a typical bundle of consumer goods and services over time. It is commonly used to measure inflation.


A sustained decrease in the price level. The opposite of an inflation.


A policy of decreasing the rate of growth of the money supply gradually over an extended period of time, so that inflation can adjust with smaller unemployment cost. Contrast with cold-turkey policy.

Incomes Policy

A policy designed to lower inflation without reducing aggregate demand. Wage/price controls are an example.

Interest Rate, Real

Nominal interest rate less expected inflation.


Nonaccelerating inflation rate of unemployment. See natural rate of unemployment.

Natural Rate of Unemployment (NRU)

The level of unemployment characterizing the economy in long-run equilibrium, determined by the levels of frictional, structural, and institutionally induced unemployment. At this rate of unemployment, inflation should be constant, so it is sometimes called the nonaccelerating inflation rate of unemployment, or NAIRU.

Phillips Curve

Relationship between inflation and unemployment.

Purchasing Power Parity

Theory that says that over the long run exchange rate changes offset any difference between foreign and domestic inflation. This result assumes that the real exchange rate remains constant, something that is not true even in the long run.


Simultaneous existence of high inflation and high unemployment, or simultaneous existence of rising inflation and r sing unemployment.


The adjustment of benefits to compensate for the effects of inflation.







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