What Is Inflation and How Does it Affect You?

What Is Inflation?

Inflation refers, generally, to an increase in prices, and is most often quantified in a percentage sense.

When you see the word “inflation” in the headlines, what they usually mean is that prices have been going up generally for a group of goods and services that make up the total of what the average American family spends each month. Price increases in one section of the economy may be accompanied by price decreases in another, and vice versa; this is only one example of how inflation may be monitored in various sectors.

To What Extent Can Inflation Be Gauged?

The rate of inflation is often reported as a percentage that compares the average price level from the previous year or month to the current level of prices. You can easily determine whether prices have increased or decreased by comparing identical items.

Products and services are categorized in order to calculate inflation. There are several ways to accomplish this, but one of the most frequent is to look at the consumer price index (CPI), which is an indicator of general price fluctuations in metropolitan areas and is released monthly by the United States Bureau of Labor Statistics. Housing, food and drink, medical care, clothing, transportation, education and communication, entertainment, and other products and services are all included into CPI calculations. 

Core inflation, which removes the far more volatile categories of food and energy from CPI data, is another frequent statistic that provides consumers with a more long-term comparative view of inflation. The core PCE price index is an additional standard inflation benchmark that may be used in conjunction with the core PCE price index to determine core inflation.

The BLS also publishes the producer price index, or PPI, which tracks the cost of raw materials for domestic manufacturers.

A price increase can’t be pinned down to one factor. Inflation may be caused by a variety of factors, but there are a few primary categories that can be identified by looking at supply and demand.

When supplies are low, those who still have access to a product or service may charge more. There are also periods of very high demand, during which those who provide the products or services in question might command a price premium.

Economists often talk about “built-in inflation,” which occurs when the mere anticipation of future price increases causes the expectation to materialize. Businesses may implement price increases if they anticipate future increases in the cost of raw materials or employee salaries. If enough people do this, the ripple effect of the unexpectedly high prices will spread across the economy and hurt everyone.

Inflation: Who Gains and Who Loses? 

As could be expected, those who own or have access to products and services that are experiencing price increases stand to gain the most. Businesses in the energy sector, for instance, gain when oil prices go up. However, in an inflationary climate, occasionally gains accrue to other, unrelated sectors of the economy.

The “wealth effect,” in which people spend more money as their wealth increases, is especially noticeable among American consumers when stock prices or real estate prices are on the rise. It seems counterintuitive that when local real estate values rise, business at area restaurants and shops would improve. However, the contemporary, interdependent economy is intricate and influenced as much by feeling as by logic. Thus, the list of those who benefit and those who suffer from increasing prices is often considerably wider than simply those directly involved.

Read more on “How to Survive During Inflation“.

Is there any way to slow down inflation?

Just to cut to the chase, sure. However, doing so in a manner that doesn’t create permanent damage is very difficult due to the interrelated structure of the global economy and the potential negative consequence of deploying such instruments too aggressively. 

The Federal Reserve has already indicated that it plans to boost interest rates to curb inflation. This might reduce demand and bring down prices, but it would also create significant obstacles for companies trying to invest and people looking to purchase a new house. 

In severe instances, the government may also use price restrictions as a tool in its arsenal against inflation. When companies lose control of their selling price, they frequently react by reducing employee pay or other cost-cutting measures. Price controls are not considered as a long-term solution to inflation in today’s market-driven economy. 

Reasons Why Understanding Inflation Is Important:

With a yearly rise of 8.5%, the March 2022 CPI was the highest figure since 1981. The fact is that many costs are going up, even if some of them aren’t nearly as dramatic as the ones we’ve seen in the examples above. 

That impacts more than just your ability to afford necessities like groceries and petrol. It’s significant because if your earnings aren’t growing at a rate of 8.5%, you’re falling behind. It’s a simple matter of math: if your investment portfolio isn’t generating at least the rate of inflation, you’re really losing ground. If you want your retirement savings to last as long as possible, you must take inflation into account.

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