What Is Purchasing Power and How Does Inflation Affect It

If your grocery bill, rent, and gas tank all seem to cost more than they did a few years ago, you're not imagining it. According to Bureau of Labor Statistics data, $100 in 2020 has roughly the same buying power as $128.67 today. Same dollar, less power. That's purchasing power at work.

Purchasing power is the value of a unit of currency measured by the quantity of goods and services it can buy. When prices rise (a phenomenon called inflation), purchasing power falls, which means each dollar buys less than it did before. The Consumer Price Index (CPI), published monthly by the U.S. Bureau of Labor Statistics, is the most widely used measure of changes in U.S. consumer purchasing power.

Below, we'll walk through what purchasing power means, how it's measured, why inflation chips away at it, and what you can do to help protect yours.

What purchasing power actually means

Purchasing power, sometimes called buying power, is the amount of goods and services your money can claim at any given moment. If a movie ticket cost $10 last year and costs $11 today, your $10 bill has lost some of its purchasing power. Your dollars are the same. What they can buy has shrunk.

Economists often draw a distinction between nominal and real dollars when talking about purchasing power. Nominal dollars are the actual amounts you see on a price tag, in your paycheck, or in your bank account. Real dollars are nominal dollars adjusted for inflation, so they reflect what your money can truly buy. A $50,000 salary in 2010 isn't the same as a $50,000 salary in 2026, even though the number is identical. The real value is meaningfully lower today.

This is why purchasing power matters so much for long-term planning. A savings account holding the same dollar amount it did 5 years ago has actually shrunk in real terms, even if the balance looks identical.

How is purchasing power measured

The most widely used yardstick for tracking U.S. purchasing power is the Consumer Price Index (CPI). Published every month by the U.S. Bureau of Labor Statistics, the CPI tracks the average price change for a fixed basket of goods and services that the typical American household buys, including food, housing, transportation, medical care, and recreation.

When the CPI goes up, prices in that basket are rising and purchasing power is falling. The percentage change in CPI from one period to another is what we typically call the inflation rate. For historical CPI data going back decades, the Federal Reserve Bank of St. Louis maintains a free public database called FRED, which is widely used by economists, journalists, and investors.

The CPI isn't perfect. It's based on a representative basket and can't capture every household's spending. But it remains the most consistent way to compare prices across years.

How inflation erodes purchasing power

Inflation is the steady rise in the general price level of goods and services. A small amount of inflation is normal in a healthy economy. The Federal Reserve targets an average inflation rate of 2% over the long run, which it considers consistent with stable prices and maximum employment.

The past few years have been a different story.

After decades of relatively low inflation, prices surged in the wake of the COVID-19 pandemic. According to the BLS, U.S. inflation peaked at 9.1% year-over-year in June 2022, the highest annual rate since 1981. The Federal Reserve responded by raising interest rates aggressively, and inflation cooled to 2.9% by December 2024 and 2.7% by December 2025. As of April 2026, the BLS reported annual inflation at 3.8%, driven largely by a sharp rise in energy prices.

The cumulative effect is striking. From January 2020 through April 2026, the Consumer Price Index rose roughly 29%, based on the news release from BLS. In plain English, a dollar in early 2020 had only about 78 cents of buying power by the spring of 2026. Groceries, rent, used cars, and restaurant meals all cost meaningfully more than they did 6 years ago.

This is also why even a "good" return on savings can leave you behind. A 1% interest rate on a savings account, when inflation is running at 3%, means you're losing about 2% in real purchasing power each year. Your balance grows in nominal terms, but what it can buy can shrink.

What is purchasing power parity (PPP)?

Purchasing power parity, usually shortened to PPP, is the international version of this idea. It's an economic theory that compares how far the same amount of money goes in different countries. The theory holds that, in the long run, exchange rates should move toward a level where a basket of goods costs the same in every country once converted to a common currency.

The most famous illustration of PPP is the Big Mac Index, created by The Economist in 1986 as a lighthearted way to compare purchasing power across countries. The idea is simple. McDonald's sells a roughly identical Big Mac in dozens of countries, so the local price of a Big Mac says something about local prices and currency strength. As of January 2025, the average Big Mac cost $5.79 in the U.S., $7.99 in Switzerland, and $2.38 in Taiwan, according to The Economist. A Big Mac in Taiwan is dramatically cheaper not because the burger is different, but because Taiwan's currency, wages, rents, and supply chain are all priced lower than in the U.S.

For more rigorous PPP measurement, economists rely on the International Comparison Program, a worldwide statistical initiative coordinated by the World Bank. The ICP collects price data on thousands of comparable goods and services across more than 170 economies, and its PPP conversion factors are used to compare gross domestic product (GDP), poverty rates, and living standards across countries.

PPP is mostly a macroeconomic tool, but it's useful context when you're traveling abroad, sending money internationally, or trying to understand why a cup of coffee costs less in Tokyo than in New York.

How interest rates affect purchasing power

When inflation runs hotter than the Federal Reserve wants, the Fed typically raises its benchmark interest rate. Higher rates make borrowing more expensive, which slows down spending and investment, which in turn cools off price increases.

That's exactly what happened during the post-pandemic inflation cycle. The Fed raised rates from near zero in early 2022 to a range of 5.25% to 5.5% by mid-2023. It pushed mortgage and auto loan rates higher but also lifted yields on savings accounts, CDs, and money market funds to levels not seen in over a decade.

For consumers, the relationship between interest rates and purchasing power runs both directions. Higher rates make borrowing painful but make safe savings vehicles more rewarding. Lower rates do the reverse.

How to protect your purchasing power

You can't control inflation, but there are a few ways to help keep your money from steadily losing ground.

Invest for returns that beat inflation

Cash sitting in a checking account can lose value to inflation every year. Historically, the U.S. stock market has averaged annual returns of about 10% before inflation, based on long-term stock market data. Even after adjusting for inflation, that's a real return that has historically helped grow purchasing power over time. Past performance doesn't guarantee future results. Investing in a diversified mix of stocks, bonds, and other assets is another way to aim for a rate of return above inflation. Diversification helps you stay invested through the normal ups and downs of the market without putting all your eggs in one basket.

Consider inflation-protected bonds

The U.S. Treasury sells two types of bonds specifically designed to keep pace with inflation. Treasury Inflation-Protected Securities (TIPS) adjust their principal value based on the CPI, so their value rises along with inflation. Series I savings bonds, often called I-Bonds, earn a combined rate that includes both a fixed rate and an inflation-adjusted rate, with the inflation portion reset every 6 months.

Build an Emergency Savings cushion

Emergency Savings on its own won't outpace inflation, but having cash in a high APY account means you don't have to sell your investments at a bad time when life throws you a curveball. That alone can protect both your long-term investing strategy and purchasing power.

Stay invested for the long haul

Time in the market matters more than timing the market. The longer your money is invested in a diversified portfolio, the more it can benefit from compound growth, which is the engine that can help outpace inflation over decades. Aligning your portfolio with your risk tolerance makes it easier to stay invested when markets get bumpy.

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Frequently asked questions

What causes purchasing power to decrease?

Purchasing power decreases primarily because of inflation, which is the general rise in prices over time. When prices rise faster than your income or savings grow, each dollar buys less. Inflation can be driven by stronger consumer demand, higher production costs, supply chain disruptions, energy price shocks, and changes in monetary policy.

How is purchasing power calculated?

Purchasing power is most commonly measured using the Consumer Price Index (CPI), published monthly by the U.S. Bureau of Labor Statistics. The CPI tracks the average price of a fixed basket of goods and services over time. To calculate how much purchasing power your dollar has lost over a given period, you can compare CPI values at two points in time and convert nominal dollars into real, inflation-adjusted dollars.

What's the difference between purchasing power and cost of living?

Purchasing power refers to what a unit of currency can buy at a given moment. Cost of living refers to what it takes to maintain a certain standard of living in a specific place or time. They're related but not identical. Purchasing power is a national or currency-level measure, while cost of living is usually local. A high cost of living is partly a reflection of lower purchasing power in that area.

How can I protect my purchasing power from inflation?

The most common ways to help protect purchasing power from inflation include investing in a diversified portfolio that aims for returns above the inflation rate, buying inflation-protected securities like TIPS or I-Bonds, keeping short-term cash in a high APY savings vehicle, and avoiding holding large amounts of money in low-interest accounts for long stretches.

Does the Federal Reserve target a specific inflation rate?

Yes. The Federal Reserve targets an average inflation rate of 2% over the long run, which it considers consistent with stable prices and maximum employment, its two main mandates. When inflation runs persistently above 2%, the Fed typically raises its benchmark interest rate to cool the economy and bring inflation back toward target.