What is Inflation

Ask a knowledgeable investor what he fears the most and the most probable answer you will receive is inflation. Inflation, in simple terms, is the sustained rise of the price of various goods and services. Inflation occurs when actual economic pressures or anticipation of future developments cause the demands for goods and services to exceed the current existing supply at existing prices. Historically, this phenomenon occurs when wars, poor harvests, political upheavals, or other unique events take place.

Currently, investors and economists track inflation through several indexes. By looking at the consumer price index, investors and economists are able to see how prices of goods and services have been behaving. Even though some reports might show a heavy increase in the price of goods, it doesn't necessarily mean there's rampant inflation.  For example, the CPI takes the price of oil into consideration and if oil prices are rising, it can skew the CPI upwards. 

Another index that investors pay close attention to is the unemployment index. If the index shows high unemployment this indicates a weak economy; if it's too strong though, investors worry about rising wages.

Even though inflation sometimes leads to short-term temporary gains, inflation eventually disrupts normal economic activities. Often during an inflationary period business spending decreases, consumer spending decreases and stock and bond prices usually depress rapidly.

Inflation is controlled mostly by the Federal Reserve System which controls the availability and cost of money and credit. The current Federal Reserve chairman is Alan Greenspan. By making these adjustments inflationary pressures are partially offset. Keeping an eye on inflation is especially important when you have money invested in stocks and bonds.