Cleveland Fed 101: What’s the difference between price level and inflation?

Key takeaways

• Price level refers to the overall or average cost of goods and services in the economy at a particular period of time, also known as the general cost of living.
• Inflation measures the rate of growth of price level over a particular span of time and is closely observed by the Federal Reserve as part of its price stability mandate.

Video summary

Research Analyst Caroline Stafford explains the difference between price level and inflation, and why the Federal Reserve pays attention to them.

Full transcript

Speaker 1: Hey, Fed fans. Welcome back to Cleveland Fed 101, where we provide basic definitions and explanations of Cleveland Fed work. Today we're talking about price level versus inflation. What's the difference? What is their relationship and how does the Federal Reserve figure into this conversation? I can try and explain this to you, but I think it would be better coming from one of our research analysts. Let's go. Hi, I'm here with Caroline and we're talking about price level versus inflation. Can you tell me what the difference is between these two?

Caroline Stafford: Yeah, absolutely. With all the talk about price level and inflation over the last five years, I can certainly understand why people find these terms confusing, but price level refers to the overall or average cost of goods or services in an economy at a particular period of time. So another way you can look at this is the general cost of living.

Speaker 1: Wait, you said the average price of goods and services. That sounds like you're talking about more than just food and gas.

Caroline Stafford: Exactly. So you can think of the price level as measuring the cost of a basket of goods and services that not only includes food and gas, but also things like new and used cars, medical care, airfare, apparel, shelter, and many other goods and services.

Speaker 1: Okay. The cost of a market basket of goods and services, that's a little clearer. So then is price level a measure of inflation?

Caroline Stafford: Not quite, but they are related. So inflation measures the growth of the price level over a particular period of time. So that is how slowly or rapidly the price level is changing. So you can think of price level as a snapshot of the overall economy's general cost of living, and then the inflation as a measure between those snapshots, and then the snapshots would normally be about 12 months apart.

Speaker 1: But sometimes I hear talk about lower inflation or slowing inflation. Does that mean the prices are falling?

Caroline Stafford: That's a good question. I think this is where sometimes people get confused. So lower inflation or a slowdown in inflation does not mean that prices are falling. It just means that prices are not rising as quickly as they were before. So if inflation goes from 4% to 2%, prices are still rising, but at a slower pace.

Speaker 1: Wait, let me see if I've got this right. So price level measures the general cost of living, while inflation measures the percentage change of the general cost of living. But wait, sometimes I hear that people say high prices today must mean that inflation is also high, but that doesn't seem right.

Caroline Stafford: Exactly. Inflation rose sharply following the pandemic, and that contributed to the large increases in price level. But remember, inflation and price level are not the same thing. So even though price level is much higher today than it was five years ago, inflation is actually lower now. That is, the general cost of living is not changing as rapidly as before. But of course, this doesn't take away from the significant impact that inflation has on households, particularly those with lower incomes.

Speaker 1: Okay. I guess that just leaves us with the question of the Federal Reserve's role in this discussion.

Caroline Stafford: Yeah. The Federal Reserve has two objectives, price stability and maximum employment. So the price stability goal is defined as a 2% inflation rate measured by a particular price index called the Personal Consumption Expenditures, or PCE price index. So the goals of maximum employment and price stability are often known as the dual mandate.

Speaker 1: Wow, okay. The dual mandate. That sounds really interesting, but I think we're going to have to leave that for another discussion. Thank you so much for sharing those differences with me.

Caroline Stafford: Yeah, you're welcome.

Speaker 1: Well, there you have it. We have tons of resources and information on inflation on our website. Check out the Center for Inflation Research today.