Combating Inflation

Introduction

??????????????? Inflation is a critical economic concept that affects everyone’s finances, but it is often misunderstood. Inflation is basically the rate at which the general level of prices for goods and services rise, resulting in the falling purchasing power of your money. This means that $1 may buy less in the future than it can now. In this article, we’ll talk about what causes inflation, how it is measured, its impacts on personal finances, and ways you may be able to insulate yourself from it. Please keep in mind that while general strategies are mentioned, this article is solely for informational purposes, and a financial professional should be consulted before making financial decisions.

What is Inflation?

??????????????? Inflation is the economic term used to describe the increase in prices over time. When inflation occurs, each unit of currency buys fewer goods and services than it did previously, effectively reducing the value of the money. Inflation is measured by two main indices: the Consumer Price Index (CPI) and Producer Price Index (PPI).

Causes of Inflation

1. Demand-Pull Inflation: this occurs when the demand for goods and services exceeds their supply. As customers are willing to pay more and more for the same goods and services, prices rise. If these price increases are sustained, it can manifest itself in inflation.
2. Cost-Push Inflation: this happens when the costs of production increase. For instance, if wages rise, raw materials become more expensive, or supply chain costs increase, producers may pass these increased costs onto the consumers in the form of higher prices.
3. Devaluation: all world currencies are compared to one another on a daily basis. Inflation can happen in a country when their native currency undergoes a significant devaluation by the larger global markets.
4. Rising Wages: This is also known as wage-price inflation. This occurs when workers demand higher wages to keep up with the rising living costs, which can be a self-fulfilling prophecy. Businesses then subsequently raise their prices to accommodate the increased living costs.
5. Monetary and Fiscal Policy: increasing the supply of money will, over time, reduce its scarcity and decrease the value of each individual unit of the currency. As more money is printed, property values tend to rise, along with the cost of living and other prices. In response to high inflation, the central bank will raise interest rates. Failure to balance monetary and fiscal policy can result in inflation.

Measuring Inflation

• Consumer Price Index (CPI): This measures the average change over time in the prices paid by consumers for a market basket of consumer goods and services. This is a key indicator of inflation at the consumer level. One basket of goods that is often used as an example is the “Big Mac Index”. This measures the price of a Big Mac over time in different parts of the world to measure inflation.
• Producer Price Index (PPI): This measures the average change over time in the selling prices received by domestic producers for their output. It is used to measure inflation at the wholesale level.

Impact of Inflation on Finances

1. Purchasing Power: As prices rise, the purchasing power of your money decreases. This means that you need more money to purchase the same goods and services.
2. Savings: Inflation erodes the value of the money you’ve saved. For example, if the inflation rate is higher than the rate that you get on your savings account, your money is actually losing value.
3. Debt: For borrowers, some moderate inflation can actually be beneficial. Besides added interest, the initial principal amount you borrow is the same. However, inflation can reduce the value of the money that you borrowed. This means that while you’re paying the same number of dollars over time, the true value that you pay over time reduces.
4. Income: Wages often lag behind inflation, meaning your income may not increase at the same rate as prices, reducing your overall purchasing power.
5. Investment Returns: Inflation can impact the real returns on investments. For example, if an investment yields a 5% return, but inflation is 3%, the real return is only 2%.

Strategies to Protect Your Finances from Inflation

1. Invest in Assets that Outpace Inflation: stocks, real estate, and commodities like gold often offer results that outpace inflation over the long term. Investing in these assets can help preserve and grow your wealth.
2. Treasury Inflation-Protected Securities (TIPS): These are government bonds typically designed to protect against inflation. Their principle value increases with inflation and decreases with deflation, providing a safeguard for your investments.
3. Diversify Your Portfolio: A diversified investment portfolio can help manage the risks associated with inflation. By spreading your investments across different asset classes, you can mitigate the impact of inflation on your overall portfolio.
4. Adjust Your Budget: Regularly review and adjust your budget to account for the changing costs in essential categories like food, housing, and transportation. Being proactive about managing your expenses can help you stay on top of them.
5. Consider a HYSA or CD: HYSAs (High Yield Savings Accounts) are a great way to protect yourself from inflation. Accounts like these offer you a high rate (APY) on your account balance, sometimes north of 5%, such as SMCU’s [link] Kasasa Cash accounts. This annual return can put a dent in or completely overcome inflation. CDs (Certificates of Deposits) can also help with this by letting you lock up some of your money in exchange for a rate (APY).

In the Long-Term

??????????????? Understanding inflation and its effects can help you make informed financial decisions. By incorporating strategies to hedge against inflation, you can protect and potentially increase the real value of your wealth over time. Staying informed about economic trends and regularly reviewing your financial plan are key steps to maintaining financial stability in an inflationary environment.

??????????????? While inflation is an inevitable part of the economic landscape, understanding its dynamics and impacts can empower you to take proactive measures to protect your finances. By investing wisely, diversifying your portfolio, and adjusting your financial strategies, you can mitigate the adverse effects of inflation and secure your financial future.