# Historical Performance of US Markets

## Historical Picture of Inflation


### Learning Outcomes

By the end of this section, you will be able to:
1. Define inflation with concrete examples.
2. Describe the practical impact of inflation on consumption and salary.
3. Explain how expected and actual inflation are measured.
4. Detail the behavior of inflation over various historical periods.
Over time, returns in the stock market have easily outperformed returns in the bond market. However, not everyone is comfortable investing in stocks. Taking a more informed and opposing view, financial economist Jeremy Siegel queries, “You have never lost money in stocks over any 20-year period, but you have wiped out half your portfolio in bonds (after inflation). So which is the riskier asset?”Jeremy J. Siegel.  Siegel brings up a valid point about inflation. Returns adjusted for changes in prices provide a better measure of value or wealth. Baseball pundit Sam Ewing noted, “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.”Sam Ewing. “Sam Ewing Quotes.”  If what you have earned on your investments fails to keep up with changing prices, you may have a larger portfolio with less purchasing power.

### Expected versus Actual Inflation

Inflation occurs when things cost more and your money buys less today than it did yesterday. It is understandable to dislike inflation and to be concerned over the prospect of rising prices. In fact, two of the primary policy objectives of the Federal Reserve are to work for price stability and moderate interest rates. However, is inflation necessarily good or bad? In practice, inflation can benefit some people and harm others at the same time. Consider the impact of differences in expected and actual realized inflation. Empirical evidence suggests that, on average, economists do a good job of developing inflation rate forecasts that match the actual rate of inflation. Estimated inflation is built into the interest rates investors require or are willing to pay for financial products, such as fixed-rate loans or bonds. When the actual rate of inflation exceeds the estimated rate on a product, such as a mortgage loan, this means borrowers are repaying the loan with less-valuable dollars and benefit from the increased inflation rate. Lenders, however, receive those inflation-impacted dollars and are harmed due to their unexpected decrease in purchasing power.
Deflation, or falling prices, is associated with economic recessions or even depressions and is thought to be an even more serious problem than inflation. Generally, policy makers tend to support moderate inflation, being careful to stay away from zero or negative price changes.

### Inflation Impacts

Ultimately, inflation redistributes wealth. Lenders providing fixed-rate loans receive less-valuable dollars in return. Borrowers repay with those same less-valuable dollars. Workers receive less-valuable dollars, especially when their wage increases lag behind changes in prices. Modest inflation can benefit a consumer-driven economy like the United States if consumers are motivated to spend money before prices increase. However, too much inflation can cause frenzied buying, drive prices even higher, and outpace the rate of wage increases. Higher inflation raises the rates on new borrowing instruments and can slow the rate of business investment and economic growth. Inflation raises overall prices and may cause hardship for consumers on a fixed income.
Finally, inflation does not have an equal impact on all goods and services. As  shows, consumer prices did not increase at the same rate for the selected items shown. From 1980 to 2020, inflation, as measured by the consumer price index (CPI), grew at an average annual rate of 2.90%. However, the price of college tuition and fees increased at more than double that rate. Rent, another large expense for most college students, increased at an annual rate of 3.67%, also well above the average increase in the CPI. The price increases for ground beef and butter were slightly less than the CPI average. For the selected items presented here, only the average price for used cars and trucks rose at a rate significantly lower than the average rate of inflation.

### Using Graphs and Charts to Plot Inflation Behavior

The CPI is a measure of how prices have changed for a basket of goods across the United States.  shows the eight major categories of expenditures included in the CPI.US Bureau of Labor Statistics. “Consumer Price Index.”  Different regions of the country and population subgroups may experience different rates of inflation. Retired people may spend a greater portion of their income on healthcare than someone in their twenties.Chris Farrell. “The Truth About Health Care Costs in Retirement.”  Residents on the East and West Coasts spend a higher percentage of their earnings on housing than those living in the Midwest.US Department of Housing and Urban Development, Office of Policy Development and Research. “Rental Burdens: Rethinking Affordability Measures.” PD&R Edge. September 22, 2014. https://www.huduser.gov/portal/pdredge/pdr_edge_featd_article_092214.html As such, there are several different measures of inflation based on geographic region or other factors.Khan Academy. “How Changes in the Cost of Living Are Measured.”  It is worth noting that a basket of goods and services that cost $100 in 1984 would cost approximately $260 by the end of 2020, an increase of 160% (see )! Over that same period, the average annual rate of inflation as measured by the CPI was 2.55%. These numbers make it easy to see that even a relatively modest annual inflation rate, lower than the long-run annual US inflation rate of 3%, results in significant price increases.

### 

The Federal Reserve considers moderate inflation rates optimal in their oversight of the US economy. We measure inflation by comparing the price of a bundle or basket of goods over time and documenting how prices change. Since not everyone consumes similar baskets of goods, we calculate several different measures of inflation. The most commonly quoted measure of inflation uses changes in the Consumer Price Index (CPI).

### 
