Effects of Inflation: Impacts on Everyday Life

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News about inflation has been everywhere over the past few years. But even if you haven’t been watching TV or reading the financial press, you’ve no doubt felt some pain in your wallet as prices for nearly everything have risen dramatically. While most Americans feel the effects of inflation, many can’t really define it, explain it or understand its deep-seated ramifications. Here’s a primer on what inflation is, the impacts it can have on daily life and what causes it to rise and fall.  

What Is Inflation?

Inflation is simply a term that applies to rising prices. The Consumer Price Index, or CPI, is the most commonly cited measure of inflation. It reflects the annual percentage change in prices for various consumer goods. So, if you hear that the CPI was up 3.5%, for example, it means that the price of the basket of goods that the CPI measures rose by 3.5% over the prior year. While not an apples-to-apples comparison, it may mean, for example, that if your grocery bill was $100 per week last year, it’s likely to be $103.50 this year. 

What Causes Inflation?

Explaining what causes inflation can take a college professor and a full semester. The simplistic, root cause of inflation is demand outstripping supply, or “too much money chasing too few goods.” But there are lots of factors that can create this situation.

The coronavirus pandemic, for example, set into motion a series of events that caused relatively extreme inflation over the subsequent few years, something from which the economy is still recovering. One of the chief problems during 2020 was that the global supply chain broke down. It was difficult-to-impossible to get needed parts and materials to feed the worldwide demand for products ranging from automobiles to furniture to smartphones, causing massive delivery delays and price increases. 

Another inflationary aspect of the coronavirus pandemic was the vast amounts of stimulus money that the government unleashed into the American economy, creating that scenario of “too much money chasing too few goods.” 

During periods of war, critical commodities like oil might stop being produced in certain regions, driving up the price of oil itself and also any products that rely on cheap oil. 

There are countless other reasons why inflation might spike, from significant jumps in wages to simple expectations of higher prices that become self-fulfilling prophecies.

Who Benefits From Inflation?

Although rising prices might seem like a negative for everyone, there can actually be some benefits to increasing inflation. Primarily, however, the benefits are on the business side. For example, some companies benefit from rising prices for their goods, such as food producers. Any business can benefit if their cost of operation and/or production doesn’t rise as fast as the cost of the prices they receive for their goods and services. 

If you have any outstanding loans, you can technically benefit by paying back what you owe with money that isn’t worth as much as you originally received. However, inflation also tends to push up interest rates, so you might have to pay more if you borrow any additional money.

When interest rates rise, it can help lenders, as they’ll earn more interest on the money they lend. But it can also help savers, as the interest rates they earn on their bank accounts also rise.

Who Is Hurt by Inflation?

Consumers are generally hurt by inflation across the board. Although wages generally rise during inflationary periods, they don’t typically jump as much as expenses. Those with lower incomes may suffer more because they can’t absorb jumps in necessities like groceries and transportation expenses as readily as those with higher incomes. 

Business can also suffer right along with consumers. If the raw materials they need to produce their products rise too high, they’ll either have to trim their profit margins or raise prices and hope that consumers continue to pay. Rising wages can also create the same pressure on a company’s profits.

Examples of Inflation’s Effects on Budgets

There’s no better way to explain inflation than to show how it affects the monthly budget of average Americans. Here are some of the most common. 

Housing and Rent Price Fluctuations

Both housing prices and rent tend to increase with inflation. This can be good if you are a homeowner, as your net worth will increase. You may also get a higher price for your home if you sell it. However, it’s important to note that if you move into a new home, you’ll also likely have to pay more.

Rents tend to increase along with inflation as well, in part because landlords have to pay higher mortgage payments themselves. Landlords may also increase rent simply to keep up with their own higher costs of living. 

Grocery and Daily Essentials Cost Changes

The price of groceries and daily essentials are important components of the Consumer Price Index. This means that when the CPI increases, your daily cost of living is likely to rise as well. Grocery prices can be particularly volatile during inflationary periods. As of March 2024, for example, grocery prices had increased by a whopping 25.8% since Nov. 2020. The average price of eggs jumped by 54% over that same time period. Although you can pick and choose which grocery items you purchase – and where you purchase them – it’s been hard for the average American household to completely escape rising grocery prices.

Education and Healthcare Cost Implications

Education and healthcare are two essential items that are subject to rising inflation just like other types of goods and services. In fact, education and healthcare costs tend to rise even more than the average gain in inflation.

Transportation and Fuel Price Fluctuations

Along with grocery costs, transportation and fuel prices can be among the most volatile components of the inflation index. In fact, spikes in oil prices are often the root cause of more widespread inflation, creating a ripple effect that results in increased costs for both businesses and consumers alike. This can have a more dramatic impact on lower-income individuals, as they have less ability to move money from other expenses to cover these essential costs. 

Impact on Savings and Retirement Plans

One of the few plus sides of high inflation and rising interest rates is that savers get a boost in the yields they earn. However, your long-term investments might suffer a few hiccups. When inflation and interest rates initially rise, stock markets typically fall, as rising costs can impact the profits that companies generate. However, as inflation and interest rates come back down to Earth, stock markets can boom.

Important to note is that the stock market is a forward-looking entity. In other words, if it appears as if interest rates and inflation are going to fall in the coming months, the stock market will likely appreciate in advance of this actually happening. If you’re a consistent, long-term investor, you should just stick with your plan through thick and thin. However, if you’re more of a trader, you’ll want to make sure you jump back in long before inflation and interest rates actually show signs of falling.

Strategies for Managing Inflation’s Effects

While it can be hard to completely avoid the effects of inflation, there are some strategies you can use to minimize its effects. These are best enacted before inflation rears its ugly head, but they can still be effective even after prices start rising.

Reduce Spending

Cash is king during periods of high inflation and interest rates, which often lead to recessions. As the likelihood grows that you may lose your job or may need your money to stretch further, it’s a good idea to reduce spending and boost emergency cash reserves as much as possible. 

Eliminate High-Interest Debt

Eliminating high-interest debt should always be high on your list of priorities, but even more so during inflationary periods when your budget may get tight. Without having to make debt service payments, you’ll have more available cash in your budget for your basic necessities.

Comparison Shop

While it’s always a good strategy to shop around for the best prices, it takes on even greater importance during inflationary periods. Although prices in general might be rising across the board, it’s highly likely that you can find different prices for different items if you shop around, as various merchants pick and choose how best to price their products.

Boost Your Income

One of the best ways to combat rising prices is to boost your income. During inflationary periods, your employer might be more willing to raise your salary, as wages are generally expected to increase during high inflation. You might also consider taking on a side gig to supplement your income and fend off the effects of rising prices.

Keep Extra Cash in a High-Yield Savings Account

Although you can’t control rising inflation and interest rates, you can take advantage of them when they occur. High-yield savings accounts raise their interest rates right along with the overall market, and as a saver, you can benefit. During the coronavirus pandemic, for example, high-yield savings accounts paid an APY of below 1%. As of July 2024, however, you can find numerous accounts that pay over 5%. While this won’t solve all of your inflationary problems, it can significantly boost the return you earn on your idle cash. 

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