What is Inflation?
Learn More About
What Inflation Is and How It Affects Your Bottom Line!
Although the term inflation may be one of
the most familiar words within the world of economics, there are still many people who aren’t fully aware of how inflation
works or how it can affect us as individuals. Inflation is a term that is used
to describe the general increase in prices and fall in the purchasing value of
money, but the truth is, it can be far more complicated than that. Continue
reading to learn more about the different types of inflation and why you need
to pay attention to them.
What is
Inflation?
A simple definition of inflation is the
constant rise in the price of goods and services.
When the prices for energy, food, and
other goods or services rise, our entire economy is affected. Rising prices
will often impact the cost of living, the cost of doing business, the cost of loans, mortgages, and every other component of the economy. More often than not, inflation
is described and considered to be bad for an economy, but that’s not
necessarily true. It’s important to know that inflation is inherently a little
unstable and that it can be both beneficial and detrimental to an economy.
Moderate inflation can be good for the growth
of an economy while hyperinflation often has a negative effect. Hyperinflation
means that inflation is occurring at an extremely high rate. To put it simply, if inflation becomes too high, the economy can
suffer, but if it is controlled at reasonable levels, the economy may thrive.
What Causes
Inflation?
There are essentially three ways in which
inflation can occur. The first is what many economists call “cost-push
inflation”. This is where the cost of running a business rises and that cost is then pushed onto customers through increased
prices. If the cost of materials, employees, or land rents increase – many businesses will have no choice but to
raise prices to stay in business, even though it can be a risky move.
The second kind of inflation is called
“demand-pull inflation”. This is when
the number of people who want to purchase a certain product increases past the point
of production. The cause of this type of inflation generally comes down to the
increase of income and disposable income. For example, the government can cause this type of inflation by lowering taxes,
which raises disposable income, which can then raise the demand for a product.
That demand will then lead to the rising of prices. We see this same sort of
inflation after interest rates have fallen.
Lowered interest rates may offer short term relief when it comes to purchasing
power, but it will cause long term inflationary pressure in the future. Say for
example the interest rates on loans or mortgages have lowered, leaving you tempted to take out a loan for a new vehicle. Soon the car companies are
going to recognize that there is a solid trend in demand and that they need to
raise the prices of their vehicles. This type of inflation tends to be
cyclical.
The third type of inflation is when governments “print more money”. Governments will often want to stimulate the
economy in order to create jobs. In some cases, the printing can be done by
literally printing and circulating new notes but, it can also be done by
increasing government debt, or by allowing banks to give bigger loans on the
same security. In each case, the amount of money that is in circulation
increases, which will eventually cause the worth of the individual dollar to
fall. The value of the dollar
decreases in this case because now there is more money chasing after the same
number of things there are to purchase. You may technically have more money,
but that money won’t purchase you more in the long term.
How Does This
Affect Your Bottom Line?
Purchasing Power
Generally speaking, no matter what kind
of inflation is taking place, inflation will affect your buying power. We all
know that prices tend to increase over time. For example the average cost of a movie ticket today is around $9, but in the 1950’s the average
cost of a movie ticket was $0.49. With
inflation comes a higher cost of living which is something to consider when
planning out your financial goals. On the other hand, inflation allows individuals
to pay back their loans and
mortgages with money that is less valuable than when it was borrowed, which can
be considered a benefit. Rising inflation can trigger companies to offer increased wages which can be good for
morale, productivity and the individual’s purchasing power if managed properly.
Savings,
Retirement, and Salaries
If you have any investing or long-term
savings goals,
inflation is something you will want to be aware of. Over time, inflation can
reduce the value of your savings if it outpaces the interest you earn in your savings accounts. In
order to combat this, you might consider opening a high yield savings account
that can offer you a better-earned interest rate or you may be interested in
learning about investments. You will
want to account for inflation when planning out your savings and retirement goals as well as when you are negotiating your salary
as it will have a long term effect on your money.
Practicing good financial health habits can make the difference between being able to retire or
having to work for more years. It’s critical to educate yourself and your family not only on the importance of financial
planning, but also understanding how the economy can affect your financial future. To learn more about financial wellness from our Chief Financial
Officer, Chief Risk Officer, and Treasurer, Mike Perrino, check out the link
below!
