Say the same basket costs $100, then $104 a year later, then $106.08 the following year. Inflation falls from 4% to 2%. Your bill keeps rising.
Inflation tells you how fast prices change; the bill tells you where prices have arrived. Slowing down does not put you back where you started.
The difference matters for what your money can buy. To read an inflation headline, you need three labels: the index, the spending it covers, and the comparison period.
A basket becomes an index
A price index combines price changes across spending categories into one weighted average. Its reference level is a choice: setting a starting period to 100 gives you a ruler for later changes. The index level itself is not an inflation rate.
For our basket, (104 ÷ 100 − 1) × 100% = 4% in the first year. The second increase is $2.08 on $104: 2%.
That slowdown is disinflation. Deflation means the overall price level falls. Here the bars keep growing: across both years, the basket is 6.08% more expensive.
An expenditure weight is a category's share of spending. The bigger the share, the more that category's price changes move the total.
In a separate basket, suppose you spend $60 on shelter, $30 on food and $10 on energy. Over one year, their prices change by +4%, +6% and −10%. Buying the same quantities then costs $62.40 + $31.80 + $9.00 = $103.20, a 3.2% increase.
Energy saves you $1; shelter and food add $4.20. The large shelter share keeps the total rising even as energy gets cheaper.
Averaging the three percentage changes equally would give zero. Your budget does not give every category an equal vote.
Your spending shares can differ from the national ones. An accurate inflation reading can still be a poor description of your own bills.
Headline and core
Headline inflation covers the whole basket. Core inflation excludes food and energy, whose sharp swings can hide the underlying trend. Core helps you see price pressures that may last; it does not measure the full increase in your household bills.
Removing food and energy from our three-category basket leaves only shelter. That stripped-down core rises 4%, against headline inflation of 3.2%. Real core indexes contain many more categories. Excluding volatile prices does not always produce a lower number.
CPI and PCE
The Consumer Price Index (CPI) comes from the Bureau of Labor Statistics (BLS). It tracks prices for US urban consumers.
The Personal Consumption Expenditures (PCE) price index comes from the Bureau of Economic Analysis (BEA). It covers the personal sector: households and the nonprofits serving them. Both indexes have headline and core versions.
| Measure | Producer | Spending covered |
|---|---|---|
| CPI | BLS | Mainly out of pocket |
| PCE | BEA | By and for the personal sector |
Medical care shows the difference: PCE includes care paid for by employers or government as well as households.
The indexes give categories different weights and combine price changes with different formulas. Different answers need not mean one report is wrong.
Neither basket is frozen forever. CPI updates spending weights and allows for some switching between purchases within a category. PCE's formula captures spending shifts across categories too.
Compare the same clock
Month-over-month compares adjacent months. Year-over-year compares a month with the same month a year earlier. One measures the latest step; the other measures the distance traveled over twelve steps.
For a separate example, say an index has these levels, with no seasonal pattern:
| When | Index level |
|---|---|
| A year earlier | 100.0 |
| Last month | 103.0 |
| This month | 103.2 |
- Year over year: (103.2 ÷ 100.0 − 1) × 100% = 3.2%.
- Month over month: (103.2 ÷ 103.0 − 1) × 100%, about 0.19%.
Here, a rise of 0.2 index points is about a 0.19% price increase. Index points and percentages are different units.
Seasonal adjustment removes estimated recurring patterns, such as holiday sales, to make adjacent months easier to compare. US CPI releases pair a seasonally adjusted monthly headline with an unadjusted twelve-month change. For your own calculation, use the same index and adjustment at both ends.
A base effect comes from the old comparison month. Suppose prices jumped last July and have crept up since.
This June's yearly comparison still includes that jump. This July's comparison starts after it, so annual inflation can fall while prices keep rising. The annual rate carries news about the past as well as the present.
What the Fed's 2% goal means
The US Federal Reserve aims for 2% inflation over the longer run, measured by the annual change in overall PCE. The goal includes food and energy.
The choice is a policy judgment. In 2012, then-Fed Vice Chair Janet Yellen described it as keeping inflation low while leaving a buffer against damaging deflation. The Fed chose 2% to interpret Congress's price-stability mandate; Congress did not write the number into law. It is not a monthly ceiling.
Read a release in context
The BLS release for January 2025 reported these headline CPI increases:
- From December: 0.5%, seasonally adjusted.
- From January 2024: 3.0%, unadjusted.
Prices rose over both periods. The 3.0% describes a January-to-January change, not average inflation during the calendar year. And a CPI reading cannot tell you whether PCE has reached the Fed's goal.
To judge the trend, compare recent readings on the same basis and look across categories. A lower rate driven by cheaper fuel tells a different story from slower increases spread across many categories.
An inflation surprise can change the rate outlook that stock prices respond to. Use the same index and period when comparing the result with forecasts.
To tell whether higher spending means more production or just higher prices, turn to real GDP.
In short
- Lower positive inflation means prices rise more slowly, not that they fall.
- A weighted index measures an average, not your exact spending.
- CPI and PCE both have headline and core versions; core excludes food and energy.
- A monthly rate measures the latest step; a yearly rate covers twelve months.
- The Fed's 2% longer-run goal refers to overall PCE inflation.