What Do You Know About Inflation?

Inflation can be annoying to most investors. It attacks the value of their portfolios, causing the real return to shrink. Although most people regard inflation about as warmly as they do the bogeyman, how much do you really know about it? Take this short quiz and find out.

1. When inflation increases, …
   1. the dollar gains against the euro, but loses against the yen.
   2. the general level of prices for goods and services decreases.
   3. the purchasing power of the dollar decreases.
   4. tech stocks double in value.
2. One way the Federal Reserve attempts to combat a high inflation rate is by:
   1. raising interest rates.
   2. lowering interest rates.
   3. raising the CPI.
   4. lowering the CPI.
3. Inflation is measured by:
   1. the Consumer Price Index.
   2. the S&P 500.
   3. commercial banks.
   4. polling a random sample of economists.
4. A healthy economy usually experiences:
   1. no inflation.
   2. moderate inflation.
   3. high inflation.
   4. deflation.

Answers:

1. (C) The purchasing power of the dollar decreases. When inflation occurs, it costs more for the same goods and services. For example, with annual inflation of 4%, an item that cost $1 last year would cost $1.04 now.
2. (A) Raising interest rates is one way to slow down the economy, helping to curb inflation.
3. (A) The Consumer Price Index (CPI) measures price changes in consumer goods and services. The Federal Reserve uses the CPI, among other indicators, to determine interest rates.
4. (B) Moderate inflation. High inflation hurts consumers and those on a fixed income. No inflation can be a sign of a stagnant economy. Moderate inflation (around 2% to 3%) can be a sign of a growing economy.