The Real Impact of Inflation
Inflation can decrease your purchasing power over time, so it's best to prepare for its effects.
Now that the economy has recovered from the Great Recession, concerns about inflation are becoming more commonplace. The ideal rate for inflation is said to be 2 percent, which is considered to signify a healthy economy, but the higher the rate, the more detrimental things can become. The idea is that consumers generally expect prices to increase by small amounts, but when prices get too high, it becomes more difficult for many people to afford the goods and services in question, and as a result, they buy less, and business and the economy at large suffers.
The projected inflation rate for 2018 is 2.38 percent1, and many signs are pointing to an increase this year. Jeanna Smialek and Matthew Boesler at Bloomberg2 cite the following as contributing to a projected rise this year: strong domestic and international economies, the lowest unemployment rate in 17 years, oil’s return to above $70 a barrel, a softening dollar, American companies boosting pay packets, and about 20 states raising their minimum wages.
The Bureau of Labor Statistics measures the Consumer Price Index (CPI), which is the best measure of the inflation rate. The CPI measures changes in the price level of a "basket of goods and services" that would be purchased by a household. To have a good sense of the current inflation rate at any given time, check out the Bureau's CPI page.3
According to January data4 from the Bureau, the Consumer Price Index for All Urban Consumers (CPI-U) increased 0.1 percent in December, and over the last 12 months, the "all items index" rose 2.1 percent before seasonal adjustment.
Marc Davis at Investopedia writes, "Inflation can be both beneficial to economic recovery and, in some cases, negative. If inflation becomes too high the economy can suffer; conversely, if inflation is controlled and at reasonable levels, the economy may prosper. With controlled, lower inflation, employment increases, consumers have more money to buy goods and services, and the economy benefits and grows. However, the impact of inflation on economic recovery cannot be assessed with complete accuracy."5
Impact on Cost of Living
Inflation affects cost of living in many ways. It surfaces as increased prices for food, gasoline, mortgage rates, utilities, rent, etc. Essentially, dollars don't go as far as they did before. Naturally, the middle and lower classes are hit the hardest and have a more difficult time making ends meet. In turn, it also means less money for savings, so it's even harder for folks to put money aside for the future.
People on fixed incomes may find their purchasing power decreasing over time, as goods and services cost more while their income remains the same. Therefore, most retirement plans have a built-in cushion to allow for the long-term effects of inflation.
Of course, the housing market is a major part of living, and inflation has a significant impact on it. While real estate tends to rise in price when inflation hits the market, some other things happen behind the scenes that have an impact on consumers.
As Investopedia contributor Michelle Ullman explains6, "To keep inflation rates under control, the Federal Open Market Committee (FOMC) often steps in and raises the Federal Funds Rate, which is the interest rate charged to other financial institutions using the Federal Reserve Bank. As the cost of home loans goes up, many consumers are squeezed out of the market, leading to a slowdown in home sales. With homes on the market for longer periods, sellers tend to drop their asking price to attract buyers."
Impact on Cost of Doing Business
Beyond the cost of living, inflation also impacts the cost of doing business. This surfaces in a number of ways, including, but not limited to: property/rent costs, inventory costs, consumer purchases, and employee wages.
Simply put, when high inflation rates are hitting consumers, they hit businesses as well. If consumers have less money to spend, they're not going to be buying as many goods and services, so businesses - especially those offering non-essentials - are more likely to suffer as a result. Meanwhile, businesses must also contend with many of the same obstacles consumers themselves are facing.
When money is tighter, there's not as much available for purchasing inventory. Perhaps the ideal location also becomes less affordable, which means revenue can suffer. Simply changing prices to keep up with inflation can cost a business. A restaurant, for example, would have to have new menus printed and/or change advertisements/coupons. A retailer would have to put forth the effort and resources required to change price tags throughout the store.
While extreme Inflation can be severely detrimental, up to a certain point it is perfectly healthy for the economy and can actually help both businesses and consumers. If businesses are able to make more money from increased prices, they can afford to pay employees more, who can then spend more.
If you have concerns about how inflation might affect your finances, it may be wise to schedule an appointment with your banker to discuss your savings and retirement plans.
The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice. Any views expressed in this article may not necessarily be those of Nevada State Bank, a division of ZB, N.A.