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July 1, 2022
In the 1950s, you could buy a loaf of bread for 14 cents, toothpaste for 29 cents a tube and a tank of gas for about 20 cents a gallon.
Sounds like a deal in today’s dollars, right?
Most of us are probably familiar with the term “inflation,” which can help explain why the prices for goods and services have gone up over the years.
In this article, we’ll go over how inflation works and what it means for your wallet.
Inflation means that the overall price of goods and services has gone up. If the buying power of a currency doesn’t increase accordingly, the currency loses value. With a devalued currency, you essentially have to spend more money to buy the same thing – that’s what we mean when we say there’s a decrease in purchasing power.
Let’s talk groceries again to illustrate this. Ever heard a parent or grandparent say that when they were a kid, they could buy a soda for a nickel?
As you know, that’s not the case anymore. Buying a soda at a gas station these days will usually cost you at least $2. This is an example of how inflation can reduce purchasing power. You now need more dollars to buy the same soda.
In this way, rising inflation can increase the general cost of living over time. And in the long run, that could slow economic growth since people can’t afford as much as they could previously.
But not only do customers feel the pinch in times of rising inflation. Businesses can feel the squeeze, too.
Say you’re the grocery store owner in the example above. Rising inflation can mean higher business operating expenses, as the cost of equipment, supplies and utilities become more expensive. All of which can affect a business’s bottom line. Businesses could then, in turn, raise their prices to help offset those higher expenses.
The inflation rate is a measurement of inflation. In the US, one popular way of measuring the inflation rate is using the consumer price index. That index tracks how prices of a preselected basket of goods and services change over time.
As of May 2022, the inflation rate stands at 8.6%. That means that consumer prices have gone up approximately 8.6% from May 2021 to May 2022, based on the consumer price index.
The answer may surprise you: Inflation could be good depending on a few factors.
When inflation is mild, the possibility of prices going up in the near future can increase consumer demand for goods and services, which can help boost economic growth. So not only is a little inflation normal, it’s even considered necessary by many economists.
Inflation can also be necessary because it helps counter the risk of deflation.
Deflation is essentially the opposite of inflation. Deflation occurs when the overall price of goods, labor and services goes down. So the purchasing power of currency goes up, and less money is required to buy the same things.
When deflation occurs, people might expect prices to drop, so they’re less willing to pay for something now if they think the price will be even lower in the near future. That expectation could decrease demand, which in turn could decrease output from producers and could lead to layoffs. Unemployment may then rise, leading to falling wages.
Bottom line? When it comes to inflation, it’s all about finding balance. While mild inflation can be helpful, a high rate of inflation can spell economic trouble, such as rising prices and a slow economy.
In times of rising inflation, we often look to the Fed for help in keeping prices under control. For example, they may adjust the supply of money, so there’s less in circulation. One way to do this is by raising the federal funds rate, which can impact the interest rates that bank offer on their financial products, such as savings accounts, mortgages and personal loans.
Because inflation can mean higher interest rates, you may want to think carefully about taking out any new loans in times of high inflation.
While at the individual level we may not be able to do much about the rate of inflation, there are a few things we could do to help limit its impact on our finances:
This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this site were commissioned and approved by Marcus by Goldman Sachs®, but may not reflect the institutional opinions of The Goldman Sachs Group, Inc., Goldman Sachs Bank USA or any of their affiliates, subsidiaries or divisions.