Optimum Rate of Inflation

The rate of inflation (price increases of goods) is a powerful indicator of economic activity and is a key tool in determining American economic policies. An inflation rate of 0.7 to 1.4 percent is considered to be optimal, according to the Economic Review magazine.

What Is Inflation?

• The rate of inflation is a measure of the strength of a currency in terms of its purchasing power of a pre-determined sample of commonly purchased goods. It is measured by the Consumer Price Index (CPI) and Personal Consumption Expenditure (PCE) index. It is modulated by the Federal Reserve by varying interest rates to either cool an overheated economy or stimulate a sagging one.

Deflation

• Deflation (a negative inflation rate) will collapse an economy by stifling investment and economic growth as prices fall. Very low rates of inflation also discourage saving.

High Inflation

• An inflation rate of more than 3 percent causes unsustainable growth which will ultimately lead to an economic boom and bust cycle. Overinflated prices will eventually dampen consumer demand and boost unemployment.