What You Need to Know About Inflation

What Is Inflation?

Inflation is defined by the decline of purchasing power due to the rise in prices of many goods and services. As a unit of currency (such as the US dollar) loses value with inflation, consumers aren’t able to purchase as much. A popular example is thinking back to the price of a movie ticket or gallon of gas in the 1950s. You couldn’t buy either one of these items for the same  price today.

The most common method of measuring inflation is the Consumer Price Index. The CPI takes the buyer’s perspective into account by measuring price changes for items purchased in most households. It calculates the weighted average of prices from a “basket” of goods and services and tracks these price changes over time.

Financial regulators implement monetary policy to try to keep inflation under control so it doesn’t become detrimental to consumers and businesses. The Federal Reserve is the central bank of the United States, and they are in charge of controlling inflation by regulating interest rates. In early 2022, it released a Federal Open Markets Committee (FOMC) statement that determined a 2 percent objective for inflation over the longer run. The central bank believes that this is the right amount of inflation for the US to achieve a strong job market and healthy economy.

What Causes Inflation? 

Different economic environments can lead to different types of inflation. In one case, there may be a stark increase in the number of people who want to buy something, but the product supply hasn’t changed. As a result, the company will hike up prices in response to demand. For example, when the Covid-19 pandemic first hit, there was a dramatic increase in demand for items such as hand sanitizer, so its production and prices both went up. This is called “demand-pull” inflation.

Another example can be found in nonrenewable resources such as oil. When external forces such as natural disasters or international conflicts limit supply and the demand is the same, then prices and production costs go up. This is called “cost-push” inflation. Both of these environments cause inflation and price hikes for consumers.

How Does This Affect Me?

As inflation increases, consumers don’t enjoy watching the value of the money in their bank accounts diminish. When their purchasing power is at its highest, people like to spend money or invest to get their dollars’ worth. When there’s a healthy amount of inflation, it encourages consumers to spend money, which stimulates economic growth. Inflation also raises certain asset values, which can benefit people trying to sell property.

If people are looking to invest their money during this time, there are options that protect them better against inflation. Some of these include gold, exchange-traded funds (ETFs), real estate investment trusts (REITs), and treasury inflation-protected securities (TIPS). It’s always a smart idea to discuss your investment options with a trusted advisor. 

However, if inflation rates are surging and wages aren’t increasing with them, it can feel like a salary cut. Business owners may feel forced to raise prices to stay afloat, but many people see their purchasing power decline quickly and they start to cut back on spending to save money. As a way to protect yourself, it’s a good idea to stay informed on inflation, and in the meantime, you can assess your budget or talk with a professional to take the proper steps to protect your financial well-being.