Inflation is a word that is often tossed around in economic communities, but really nobody is sure what it is and how it affects their everyday lives. From the cost of groceries going up to rents increasing, to the general cost of living going up, inflation is a problem that reaches everyone. In this blog, we are going to explore the causes of inflation, its impact on people and the economy, and most importantly, how you can save your money during times of increasing prices.
Ultimately, inflation is defined as the collective rise in goods and services pricing over time. As inflation gets higher, purchasing power for money falls, whereby the same figure of money procures fewer services and goods compared to its purchasing power previously. Inflation most commonly is reported by national benchmarks such as the Consumer Price Index (CPI) or Producer Price Index (PPI). These indices monitor movements in the prices of a representative basket of goods and services, enabling economists to make estimates of how inflation is impacting an economy.
Several causes may lead to inflation. Overall, they belong to two categories: demand-pull inflation and cost-push inflation.
This is where the demand exceeds supply. It usually occurs in a good economy where the customer has an increase in disposable income and likes to spend. If demand increases, companies will be unable to meet the demand and thus set higher prices. This usually happens when there is economic growth or if customers feel the future will be better.
Cost-push inflation arises due to the rise in production costs and companies having to raise prices so that they do not reduce their margins of profit. This results from a very broad list of reasons such as the rising cost of raw materials, wages, or petrol. For example, when the price of oil rises drastically, transport costs are higher, thus raising the cost of goods and services. These extra costs are usually passed on to consumers in the form of higher prices.
Inflation is also caused by the policies of central banks. When a central bank adds money to the economy, it results in inflation. This is so because an increased amount of money in the economy raises demand for goods and services, thus increasing prices. Central banks have tools such as interest rates and open market operations with which they can control inflation, but at times their policies end up fueling inflation if not well balanced.
Sometimes inflation is caused by what individuals think will occur in the future. If consumers, workers, or companies anticipate higher prices in the future, they might behave in a manner that leads to inflation. For instance, workers will ask for wage increases to account for anticipated rising prices, while companies will pre-emptively increase prices. This is a self-fulfilling expectation in which anticipating inflation leads to inflation.
Inflation can have far-reaching effects and touch nearly every aspect of life. Knowing how inflation will affect you and the economy helps you prepare for the future.
Inflation's sharpest bite is the increase in prices for everyday goods and services. Along with rising prices on raw materials, transport, and wages, trading companies will also raise their prices for consumers. And soaring prices such as food, gas, utility, and rent, have an impact on household budgets. Such individual living at fixed income or those who have less earning capacity will see a downturn in their standard of living because of inflation.
As costs increase as a result of inflation, the purchasing power of money goes down. For example, if you currently have $100 and inflation rises by 5%, after a year that $100 will purchase only what $95 would be able to buy today. This reduction in purchasing power is the very core effect of inflation because it reduces people's and households' ability to pay for the same items and services they previously could.
Inflation can cause an increase in interest rates, influencing the cost of borrowing. An increase in inflation can prompt the central banks to raise interest rates to slow the economy. Loans, mortgages, and credit card debt become pricier in this scenario. Increased interest rates can also encourage reduced investment and consumer spending, which can subsequently lead to slow economic growth. For people, it means increased monthly payments on debt obligations and less affordable financing options for large purchases such as homes and automobiles.
Inflation does not impact everyone in the same way. Individuals who receive wages that are not rising as fast as inflation can afford to may increasingly struggle with the rising cost of living. Conversely, those who own assets such as real estate or stocks stand to gain from inflation since the value of their assets appreciates. This leads to a growing disparity between the rich and the poor since those who are richer are in a better position to insulate themselves from the impact of inflation.
Although inflation is perhaps an unavoidable reality of the economy, there are things that you can do to insulate your money from the effects of rising prices. Taking control of your finances and monitoring trends in the economy can save you from the worst of the flood.
One of the best defenses against inflation is to invest in assets that normally appreciate when inflation is present. Real estate is one such asset since the value of real estate usually appreciates along with inflation. Stocks in certain sectors, such as energy, utilities, and consumer staples, may also be a good defense against inflation. Treasury Inflation-Protected Securities (TIPS), which are special government bonds to guard against inflation, is another choice.
Diversification is the backbone of any investment plan, and it is especially crucial in inflationary periods. Dividing your investments among different asset classes like stocks, bonds, property, and commodities will ensure that your portfolio is not too dependent on one investment. For example, precious metals like gold tend to do well in inflationary times because they are perceived as a store of value.
An emergency fund is always required, but more so during times of inflation. Living expenses can increase unexpectedly, and having some ready cash can help pay for such unexpected bills. Ensure that your savings account is a high-yield account to help offset partly the loss incurred due to inflation.
Inflation tends to make individuals reconsider their expenditures. It is difficult to prevent price increases on necessary items such as food and gas, but you can be more conscious about your discretionary expenditures. Identify methods for reducing spending on discretionary items, shop around to obtain the best prices, and hunt for discounts and offers. A budget comes in handy during such periods to monitor expenses and determine where savings could be achieved.
Inflation is a sophisticated economic phenomenon with a far-reaching influence on your financial security and the price of living. It is challenging to escape its impacts, but you can take protective measures for your money by understanding its causes and mechanisms. By investing in inflation-protected investments, diversifying your investments, controlling your spending, and having your earnings keep pace with rising prices, you can safeguard your financial future. In times of inflation, money management becomes even more critical, and people who take action to adapt to economic trends will be better placed to weather the storm.
This content was created by AI