10 frequently asked questions about inflation

What causes inflation?

First, a definition: Simply put, inflation is a decline in purchasing power over time. Inflation can be caused by a variety of factors. For example, it may increase in a hot economy where people have a lot of money to spend and companies need to raise prices to meet demand for their products. However, supply chain issues like those we saw when the global economy rebounded from the COVID-19 pandemic in late 2021 can also cause prices to rise. Global conflicts such as Russia’s invasion of Ukraine can create shortages of goods like oil, which in turn cause gas prices to spike.

Inflation is rarely caused by a single factor, so economists and policymakers often have their own interpretation of what exactly causes it. Other possible explanations for the current surge in inflation include a shift in consumer spending, historic underinvestment in infrastructure, corporate greed, recent government stimulus packages and rising wages.

Why has inflation been relatively low since 1980?

In the 1980s, high unemployment rates of more than 10% and a severe recession caused inflation to fall from historical highs of the 1970s. Since then, inflation has remained largely stable and has remained below the Federal Reserve annual target inflation rate of 2%.

During the 1990s, the correlation between low unemployment and high inflation weakened, forcing economists to consider many other factors in the inflation puzzle. Some experts suggest that central banks have adjusted their monetary policy to combat the spikes in inflation, which have kept it stable for decades. Others believe that the power of workers to advocate for higher wages has diminished with the decline of unions, which has kept wage growth stagnant and therefore reduced inflation. The rise of the global supply chain and increased international trade have also likely reduced consumer sensitivity to inflation.

Will prices go back down to where they were before inflation?

Unfortunately, there is no quick fix for high inflation. The Federal Reserve has started raising interest rates, which will make borrowing more expensive and should reduce consumer spending. Some industries are beginning to recover from supply chain issues that began in late 2021.

On the other hand, some pundits are starting to signal that inflation is increasingly likely to last longer, pointing to signs like rising rents and house prices. Overall, many economists are predicting that inflation is likely to stay above the Federal Reserve’s 2% target for the rest of 2021.

Is inflation bad?

While paying higher prices for goods and services doesn’t usually excite consumers, not all experts believe inflation is always a bad thing. A sharp rise in inflation, also known as hyperinflation, can destabilize economies, leading to hoarding of consumer goods, loss of savings, and other societal problems.

Everyone can agree that hyperinflation is a problem, but more moderate increases in inflation are debated. Inflation can be a boon for small businesses who can now charge more for their products, but at the same time it negatively impacts lenders and people on fixed incomes. Similarly, inflation can help workers if it leads to higher wages, but hurt them if prices rise faster than wages.

How does inflation affect my earning capacity or the value of my salary?

If the prices of goods are rising but your salary is not, inflation has effectively eroded your purchasing power. In other words, you cannot afford to buy as many products as before.

For example, between September 2020 and September 2021, the consumer price index rose 5.4%, according to the Bureau of Labor Statistics. Unless you received a raise of 5.4% or more during this period, the real value of your paycheck actually went down. On the other hand, when inflation goes down, your salary will go further, allowing you to buy more goods and services for the same dollar value.

What can I do to “protect” my savings or retirement against inflation?

When inflation increases, the value of cash decreases. That $10 bill can no longer buy you the same amount of groceries or gas as before. If most of your savings are in cash, you are effectively losing money in the long run as the power of the dollar diminishes.

To protect the purchasing power of your savings over the long term, experts recommend investing in a diverse set of funds to grow your money over time. Also pay close attention to interest rates. The rate hikes the Federal Reserve has already triggered are expected to eventually increase the interest rates banks will pay on savings accounts, in addition to the rates consumers pay on mortgages, credit cards and other loans. floating rate. It may not be worth putting your money into a fixed-term savings account with a low interest rate now if the banks will raise interest rates next year.

Why can’t the government just print more money?

This seems like a simple solution to the inflation problem: just give people more money to make up for the purchasing power they lose. Unfortunately, the economy does not work that way. Historically, printing more money tends to increase inflation because there is too much demand (through new money) for an unchanged quantity of goods.

In other words, increasing the number of notes and coins in circulation would only devalue the US dollar as a whole. Also, the US government is not in charge of printing money, it is our central bank, the Federal Reserve. The Federal Reserve operates independently of the federal government to shield monetary policy from political pressures.

Which industries or sectors does inflation tend to hit first?

Every inflationary cycle is different. Increased demand for a certain product, such as toilet paper hunting in the early days of the COVID-19 pandemic, could lead to price spikes in this industry. Or, conversely, disrupted supply chains could lead to higher inflation. Consider the scarcity of computer chips that contributes to the current shortage of new cars and, therefore, exorbitant car prices. Industries that tend to feel the first effects of inflation are energy, utilities, real estate, and consumer staples.

Which industries or sectors will take the longest to recover?

Inflation often hits businesses with large inventories, such as retail stores, particularly hard. When the cost of goods increases, it generally increases at both the wholesale and retail level. That means stores have to replace recently sold inventory with new products that are priced higher at wholesalers, eating away at profits. Small businesses also often suffer from inflation, as suppliers often favor larger companies in times of high demand. Since smaller companies typically purchase smaller quantities of raw materials or products in bulk, they also have less leverage with suppliers.

How will inflation affect my loans?

It depends on the type of loan you have. If you are making payments on a fixed rate loan, inflation may actually improve your financial situation in certain circumstances. Because your interest rate on a fixed rate loan does not change with market fluctuations, the value of your loans actually decreases as inflation increases and the value of the dollar decreases. However, you will only come out a winner if your wages increase at the same rate as inflation.

Conversely, as the Federal Reserve raises interest rates to fight inflation, interest rates on variable rate loans will also rise, increasing the amount of your monthly payments. Federal student loans, personal loans, and auto loans generally have a fixed rate. Credit cards, personal and home equity lines of credit, and private student loans often have variable interest rates. Mortgages can have a fixed or adjustable interest rate; check your account to see what type you have.

This story originally appeared on PennyWorks and was produced and distributed in partnership with Stacker Studio.

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