Inflation is measured by national statistical offices through a consumer price index (CPI) that tracks the cost of a basket of typical household goods. Central banks target 2% annual inflation as the level that supports growth without eroding savings too fast.
Moderate inflation is generally healthy: it encourages spending and investment, reduces the real burden of debt, and gives central banks room to cut rates in a downturn. Very high inflation (above 5%) destroys savings and complicates business planning; deflation (negative inflation) is even more dangerous because it raises real debt and discourages spending.
To outpace inflation, savers need real returns above the CPI rate. Cash in a 1% account during 3% inflation loses 2% purchasing power per year. Equities, real estate and inflation-linked bonds have historically been the best inflation hedges.
Real return = (1 + Nominal return) / (1 + Inflation) − 1
EUR 100,000 in a bank account at 0.5% interest during 3% inflation has, after 10 years, only EUR 78,000 of purchasing power in today's money.