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Inflation Explained: Your Guide to Inflation Basics

Why Does the Fed Care about Inflation?

Some countries have experienced such high inflation rates that their money became worthless. Their citizens had piles, boxes, or wheelbarrows full of money, yet they were not able to buy anything because prices had gotten so high. At such high inflation rates, the economy tends to break down. The Federal Reserve works to control inflation to provide our country with a stable economy.

The Federal Reserve cares about inflation, it’s a part of our mission

The US government established the Federal Reserve to foster economic prosperity and social welfare. Part of the mission Congress has given to the Federal Reserve is to support price stability. This means not letting prices rise or fall too quickly.

The Federal Open Market Committee (FOMC), which is the part of the Federal Reserve that sets monetary policy, sees 2 percent as the right amount of inflation. The FOMC uses annual changes in the price index for personal consumption expenditures (PCE) as its preferred measure of inflation.

How does the Fed influence inflation?

The Federal Reserve influences inflation by adjusting interest rates. When inflation is too high, the Federal Reserve typically raises interest rates to slow the economy and bring inflation down. When inflation is too low, the Federal Reserve typically lowers interest rates to stimulate the economy and move inflation higher. For a deeper look into how raising interest rates helps to lower inflation, check out our infographic.

What does the Federal Reserve have to do with inflation?

Central banks, such as the Federal Reserve, are established to foster economic prosperity and social welfare. As with central banks in many other countries, the Federal Reserve has been given specific objectives by the government, including those related to inflation, to meet these goals.

What is the Federal Reserve's "dual mandate"?

The Federal Reserve is specifically charged by Congress with objectives that were originally established in the Federal Reserve Act of 1913. These objectives were clarified in 1977 by an amendment to the Federal Reserve Act that charged the Federal Reserve "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." The goals of maximum employment and stable prices are together often called the "dual mandate."

https://youtu.be/Ou3evaK5Qig
https://youtu.be/Ou3evaK5Qig

Former Fed Chair Ben Bernanke explains the dual goals of maximum employment and stable prices and when they sometimes conflict.

Does the Federal Reserve have a specific objective for inflation?

In January 2012, the Federal Open Market Committee (FOMC)—the Federal Reserve's body that sets national monetary policy—first published its "Statement on Longer-Run Goals and Monetary Policy Strategy." In the statement, the FOMC announced that it believed that "inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate." Thus, the FOMC's 2 percent PCE inflation objective was born. A number of central banks from all over the world have inflation objectives, and many of them also seek to achieve an inflation rate of about 2 percent. Inflation rates around these levels are often associated with good economic performance: a higher inflation rate could prevent the public from making accurate longer-term economic and financial decisions and may entail a variety of costs as described above, while a lower rate might make it harder to prevent the economy from falling into deflation should economic conditions become weak.

A meeting of the Federal Open Market Committee, or FOMC.

A meeting of the Federal Open Market Committee, or FOMC. The FOMC conducts monetary policy to achieve the Fed’s objectives of maximum employment and stable prices.

Publishing a statement on longer-run goals is part of the FOMC’s emphasis on clear communication and transparency, and the statement is periodically revised. The most recent revision occurred in August 2025, when the FOMC released a revised statement that describes the current approach to achieving its inflation and employment objectives. The FOMC still views 2 percent inflation over the longer run as its definition of price stability.

Why doesn't the Federal Reserve set an inflation objective of 0 percent?

Even though inflation entails a variety of costs for society, most central banks—including the Federal Reserve—do not aim to have zero inflation. Economists tend to focus on two benefits of having a small but positive amount of inflation in an economy. The first benefit of low, positive inflation is that it helps to buffer the economy from falling into deflation, which entails just as many problems as inflation, if not more. The second benefit of a small amount of inflation is that it may improve labor market efficiency by reducing the employers' need to lower workers' nominal wages when economic conditions are weak. This is what is meant by a modest level of inflation serving to "grease the wheels" of the labor market by facilitating real wage cuts.

Why are measures of underlying inflation useful?

Monetary policymakers typically devote considerable time to discussing measures of underlying inflation, and that attention is sometimes interpreted as a lack of awareness or concern on their part with certain price changes, such as those of food or energy. But policymakers are concerned with all price changes, and they look at a large number of indicators when deciding on what actions to take to meet their objectives.

Policymakers at the Federal Reserve may recognize that measures of underlying inflation serve as a guide for the conduct of policy and not as an objective of policy. One of the objectives of monetary policy is 2 percent total inflation as measured by the PCE price index, and this objective includes food and energy. But when deciding what actions to take to meet this objective, policymakers may consider which prices changes are likely to be short-lived and which are likely to persist to choose the appropriate policy actions. Measures of underlying inflation may provide policymakers with insights into which movements in aggregate inflation are likely to be transitory and thereby help them to undertake the actions best suited to achieve desired outcomes.

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