What is inflation?
Inflation is something you have probably heard of over and over again, but do you really know what it is? Inflation is the rate of increase in prices over a given period of time. It is relevant because it tells us how much more expensive a set of goods or services has become over time. Normally, inflation is a broad measure, like the overall increase in prices over the last ten years, but it can be calculated on a smaller scale as well to make it more specific to certain needs. Inflation occurs because when the money supply grows too large, the value of the currency decreases. The relationship between the money supply and the size of the economy, which is the premise behind inflation, is called the quantity theory of money. High inflation often is a result of lax monetary policy, therefore disinflationary policies are one of the ways to reduce inflation.
Current state of inflation
The inflation rate this August had increased by 5.3% compared to last August. Price increases in August were seen in food, both at and away from home, household furnishings and operations, shelter, and gasoline. Price decreases were seen in airline fares, used vehicles, and motor vehicle insurance.
This graph reflects the United States inflation over the past year which clearly demonstrates a significant rise in inflation, however; this is a reflection of the reopening of the economy after the COVID-19 pandemic lockdown. After being stuck inside for such a long time, people were ready to make up for all the time they lost and when that happened, the extremely high demand caused shortages and price spikes. Although we cannot say for sure, this extreme rise is likely transitionary and will hopefully begin to deflate as the economy stabilizes.
A good way to look at inflation is to look at the way it affects the cost of goods you use every day. The chart below shows that many everyday costs have remained fairly stable in the last decade. Other areas of our spending also have been less affected by inflation than you may think. Many of the big costs in our lives like household bills, rent, taxes, energy costs, childcare, and healthcare have also inflated close to the rate of income.
Average price in August 2011
Average price in August 2021
Coffee (1 lb)
Bacon (1 lb)
Bread (1 lb)
A dozen eggs
Unleaded gasoline (1 gal)
U.S. Bureau of Labor Statistics. (n.d.). Average retail food and energy prices, U.S., and Midwest Region. U.S. Bureau of Labor Statistics. Retrieved October 4, 2021, from https://www.bls.gov/regions/mid-atlantic/data/averageretailfoodandenergyprices_usandmidwest_table.htm.
How inflation affects you and your saving
Most noticeable to the average person is the effect that inflation has on consumer goods. Inflation decreases peoples’ purchasing power, which results in individuals having to pay more for daily goods. Unless your wage is increasing at the same rate of inflation, eventually you will notice your paycheck is not covering as much as it once did.
Rising inflation creates higher interest rates because the Federal Reserve uses short-term interest rates to remove some of the money from the market. This is not typically beneficial for your investments because as inflation increases, the value of the investment decreases. Cash investments like your savings account are usually harmed the most by inflation because the interest gained on the account cannot keep up with the rate of inflation. Property is typically the asset that benefits the most when inflation is high because real estate prices rise with the rate of inflation. Stocks, bonds, and treasury bills are certainly still susceptible during times of high inflation but are typically safer than cash investments. It is important to recognize that during these times, the high interest rates on bonds and treasury bills and the impressive performance of a company you have stock in are somewhat skewed due to the current rate of inflation. Once the economy begins to stabilize again, your earnings and purchasing power will level out.