Most people experience price inflation when they notice costs of everyday goods rising, despite no noticeable salary increase. But is inflation always a bad thing? And if so, what steps can you take to reduce the sting of inflation in your life? Just How Bad Is Inflation for the Average Person?
What Is Inflation?
Inflation comes in many forms and influences the economy in many different ways. When most people talk about inflation, they’re referring to price inflation specifically; price inflation is a generalized, measurable increase in the prices of various goods and services throughout the economy. Prices don’t always increase at the same rate, so economists often use the Consumer Price Index (CPI) to take a reasonable average.
Because inflation is complicated, it’s hard to pinpoint a specific root cause. Most commonly, inflation sets in when currency is devalued – such as when massive amounts of new money are created out of thin air. But inflation is also influenced by basic economic variables like supply and demand, geopolitical issues, consumer confidence, and market activity.
Problems With Inflation
These are some of the biggest problems associated with inflation:
Higher Prices and Lower Purchasing Power.
Most of us begin to experience inflation when we see it at the grocery store or at gas stations. The cost of normal, everyday goods is increasing, which means the average person has reduced purchasing power. If you already struggle to make ends meet, your situation is even more desperate. If you’re used to having extra money to spend on luxuries, you may have to sacrifice some of those indulgences. If there’s a big purchase you were planning on making, you may have to reconsider it now.
Higher Interest Rates
When inflation begins to spike, the Federal Reserve typically steps in to increase interest rates – a move designed to restrict the flow of money so that inflation can be calmed. This isn’t necessarily a bad thing, since it can help get inflation under control, but it has a devastating impact on certain types of investing, like real estate investing. When the Fed increases interest rates, banks are forced to increase interest rates. And when banks increase interest rates, people can’t borrow as much money – and they pay more for the money they borrow.
Disproportionate Wage Increases
Inflation may not be such a problem if wages tended to increase at the same rate as consumer prices – but this is not the case. Prices for consumer goods increase faster than the average person’s salary, meaning you’ll be taking an effective pay cut every year that inflation increases.
Disproportionate Issues for the Poor
Additionally, inflation has a disproportionate impact on the poor. If you make a high-six-figure salary, you don’t particularly care that the cost of a dozen eggs went from $3 to $4. If you’re barely scraping by, making every dollar count, such an increase could force you to make food cuts or similarly painful sacrifices.
When Inflation Can Be Good
However, in some contexts, inflation can actually be good:
Healthy Economic Growth
The Federal Reserve aims for a small rate of inflation every year, since an inflation rate of 1 to 2 percent is considered indicative of a healthy rate of economic growth. In this context, inflation is a sign that people are frequently spending money and that the economy is growing overall.
Prevention of Deflation
No matter how bad inflation is, deflation is probably worse. Deflation is destabilizing and incredibly hard to control – but maintaining a steady rate of inflation can prevent deflation from setting in.
Some Benefits for Investors
For proponents of financial leverage, high rates of inflation are actually a good thing. Inflation reduces the value of money, so if you hold large amounts of debt, the value of your debt is reduced. Homeowners and borrowers with significant debt can benefit in an inflationary environment. Inflation also presents new investing opportunities for savvy financial experts.
A Signal for Corrective Action
Inflation also indicates unhealthy economic activity, so it functions as a signal that can help authorities get things under control. In our situation, ridiculously low interest rates have undermined our economic strength – and it’s only now that the Federal Reserve is taking action to correct it.
Preparing Yourself for Inflation
As you can see, inflation does come with some benefits, but when inflation is too high, it’s also a massive problem. If you’re concerned about the future of inflation, you can prepare yourself and your investment portfolio by reallocating your resources into safe haven assets. You can also restrict your budget, control your spending, and invest in yourself so you remain employable at the highest possible wage for as long as possible. The more proactively you work in this endeavor, the better – because our current rate of inflation is unlikely to decrease anytime soon.
