Although, it is hard to find a person who does not care about inflation, many people do not understand its role in the modern world. To cut a long story short, it is the rate of change in prices. For instance, rising inflation means you have to pay more for the same goods and services. Interestingly, this can help you in the form of income or asset inflation, such as in housing or stocks, if you own the assets before prices rise.
On the contrary, if your income doesn’t keep pace with it, your buying power declines. Over time, it increases your cost of living. If the rate is quite high, it hurts the country’s economy.
There are various types of inflation. For instance, walking inflation is 3% to 10% per year.
Furthermore, rising prices may be an indication of an economy growing very fast. In such cases, people buy more than they need as they don’t want to pay more for the same products. There is another problem as well. It is not an easy task for suppliers to meet the demand. First and foremost, neither can wages. Consequently, everyday goods and services are priced out of most people’s reach.
In certain cases, it is good for the economy. For example, when it’s mild, it has a healthy side effect. If people expect inflation, they spend more money on various goods and services because they know prices will go up in the future. It is no secret that consumer spending drives economic growth.
Inflation and its impact on the economy
Some people may not be aware of the fact that the Federal Reserve sets an inflation target. Most central banks use an inflation target of 2% and the Federal Reserve is not an exception.
As stated above, sometimes it is not bad for the economy. Nonetheless, it can be bad for your plans regarding retirement. So, your target amount must keep rising to pay for the same quality of life. To put it in another way, your savings will buy less as time goes on. To avoid such problems, it is desirable to save more money than you think you will need.
You should keep an eye on it if you hold bonds or Treasury notes. Notably, these fixed-income assets pay the same amount each year. But the situation is more complicated than it might appear at first glance.
So, when inflation rises faster than the return on these assets, they become less valuable. Many people rush to sell them, further depreciating their value. The federal government is forced to offer higher Treasury yields to sell them. Thus, most mortgage interest rates increase. Unfortunately, higher rates lower the value of your investments. Besides, higher rates also increase the cost to the federal government of financing the U.S. debt. The interest on the country’s debt rises.
The government must reduce its discretionary budget. Another solution to improve the situation is to raise taxes. If not, further deficit spending will occur.
As mentioned earlier, inflation has a huge impact on everyday life. So, it is important to learn as much as possible about its role in the modern world.