You’ve all probably heard the word “inflation” being used in conversations, so much so that it seems to be a filler word instead of one with meaning. So what is this strange word, and should you know what it means? The answer to that is yes because inflation heavily impacts your financial life decisions and goals for your future.
What is Inflation?
The economic definition for inflation is a general increase in the price of goods and/or the erosion of the purchasing power of money for the individual or business. What this means is that as the general price level (price level is the mean of current prices of all goods and services produced in an economy) increases, the consumer's ability to purchase these goods or services becomes less potent. Take, for example, the price of bread. The average price of a pound of bread in 2021 was $1.52. In 2023, that price rose to $1.99, an increase of almost half a dollar. Such small increases depict the monetary impact that inflation has on the consumer.
As stated earlier, inflation also refers to the loss of the purchasing power of money. This loss of purchasing power can be seen in the example of the price of bread. Let’s say, for example, a consumer has a budget that allows him or her to spend a maximum of $12 a month on bread. In 2021, this consumer would have been able to buy around eight loaves of bread. However, in 2023, this consumer would only be able to buy six loaves of bread with those same $12. This loss of two loaves of bread that could be bought represents the loss of purchasing power for the consumer that can be experienced during inflation.
The Current State of Inflation and How It Affects the Individual
The inflation rate in the United States is currently at 4.93%. Despite still being higher than the long-term average inflation rate (3.28%), it has drastically decreased from the record highs last year (8.26%). The record high inflation rates (which were caused by the lingering effects of the pandemic being combined with bottlenecked supply chains, disruptions to global energy/food markets from the Russia-Ukraine War, and robust consumer demand) have gone down due to contractionary monetary policy being enacted by the Federal Reserve. Yet the current inflation rate remains more than 1.5% above the long-term average, and due to this, prices of goods and services as a whole have remained inflated.
Despite the slow progress, all hope for inflation returning to its normal rate is not lost. Due to the numerous monetary policies that have been enacted by the Federal Reserve, including the notable increase in interest rates, consumer demand has slowed down significantly. This means that the prices of goods will decrease, and the spending power of money will increase. If the Federal Reserve is effective, then soon the individual’s $12 should net them eight loaves of bread again, and maybe even nine.
As of right now, until the value of the US dollar returns to where it used to be, your best course of action with any excess monetary capital you have would be to use part of it to create a diversified portfolio of stocks and bonds to mitigate investment risks.
