How inflation affects you and the economy
In June, the Bureau of Labor Statistics (BLS) announced that inflation had increased 5.4 percent in the last 12 months. But even before that announcement, high and increasing prices were a concern among a lot of people. A bigger concern among individuals was that inflation was going to be a persistent trend going forward.
To that, Jerome Powell, the Federal Reserve chairman, provided a testimony claiming that inflation was merely transitory and it would ease once the economy starts to fully recover.
Inflation has increased notably in recent months. This reflects, in part, the very low
readings from early in the pandemic falling out of the calculation; the pass-through of past increases in oil prices to consumer energy prices; the rebound in spending as the economy continues to reopen; and the exacerbating factor of supply bottlenecks, which have limited how quickly production in some sectors can respond in the near term. As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.
This is also a message that President Joe Biden shared.
Yesterday, however, the Federal Chairman, Jerome Powell announced that it is highly likely inflation will be long-lived and continue to go up.
As the reopening continues, bottlenecks, hiring difficulties, and other constraints could continue to limit how quickly supply can adjust, raising the possibility that inflation could turn out to be higher and more persistent than we expected.
Indeed inflation can sometimes be good for the economy –– i.e., if it is associated with a boost in demand and consumption. Currently, however, inflation is highly due to supply chain disruptions, which point to potentially negative consequences on the economy and our everyday lives –– especially if it is persistent as predicted, and also volatile.
Here are some of the ways through which prolonged inflation will likely affect you.
Your dollar will buy less
Inflation is, in its basic definition, an all-around and persistent increase in the level of prices of goods. And we have already seen increases in the prices of things like fuel, groceries and other necessities. When prices rise continuously, our money is able to buy less and less. This is especially harmful to low-income individuals who are less likely to see wages rise to keep up with inflation.
Some groups have, of course, touted the seemingly positive fact that wages are rising due to inflation. This, however, is misleading. A rise in nominal wages does not necessarily mean a rise in real wages. If wages are rising, but much slower than the rise in the cost of living, purchasing power becomes eroded and individuals grow poorer in return over time. The BLS actually already announced that while wages have risen in the 12 months prior to June, inflation has actually risen at a higher rate, effectively giving workers a pay cut.
Savings will be worth less
The same applies to savings and return from investments. Decreases in the purchasing power of money end up eroding the value of money, including savings. Inflation may also reduce the value of your investment returns, especially if interest rates do not keep up with the level of inflation.
Effects of inflation may, of course, not be significant at lower rates. However, over time and at higher rates it is hard to deny such effects.
There will be more uncertainty
Uncertainty is especially pronounced when inflation is volatile. When consumers and producers have a hard time predicting inflation, economic transactions become more costly. Lenders, for example, may increase the cost of lending to businesses, i.e., add an inflation risk premium, which may affect capital formation in the economy and overall business planning. Moreover, individuals invest resources and time in trying to shield themselves from the impacts of inflation, instead of focusing on more productive activities.
In addition, uncertainty about inflation has the potential to mess with the price mechanism that directs decisions in the market. Normally, changes in prices are a signal to producers to either invest more or fewer resources into producing a certain product. However, with inflation, “producers face a new problem: changes in prices may be due to changes in people’s underlying preferences and knowledge, or they could be the (temporary) result of inflation.” This may lead to the misallocation of resources if producers are unable to decipher such differences.
All in all, inflation is not without its costs. And the longer high rates of inflation persist, the higher these costs will be.