Inflation is the continual price increase of goods and services over time. In the context of today’s economic environment, many people think of inflation as a temporary circumstance that requires tightening belts and reducing spending until it passes.
A new report from the Federal Reserve Bank of Cleveland suggests heightened inflation creates lasting impacts on wealth creation, the frequency of wage negotiations and navigating purchasing decisions.
Choosing Liquidity Over Investments
When consumers have to battle high prices, they’re more likely to embrace the liquidity of cash instead of locking their money away in stocks, bonds or mutual funds. Rather than earning interest and dividends on invested money, they miss out on the wealth-building power of compounding interest.
Inflation could also make it more difficult for those who avoid excessive liquidity to choose advantageous investments. The increased pricing could distort the profitability of purchasing stock in some companies. According to the Fed’s report, elevated trend inflation is more favorable towards returns in real estate and less favorable towards stock returns. Eventually, that could also act to trigger a reduction in wages across companies.
Sticky Wages and Taxes
When the cost of living constantly increases, employees are forced to negotiate for higher wages to maintain their expenses and lifestyles. In turn, employers increase the price of their goods and services to compensate for the extra expense of higher wages. In some cases, the corporate norms discourage salary discussions and avoid frequent raises which saps workers of their purchasing power as costs keep rising.
Taxes and government regulations are also slow to change. To our earlier point, the distorted investing environment is already difficult to navigate, but certain tax rules like capital gains could negatively impact investors since the capital gains tax is tied to how much an asset’s value increases. So even when the price of some securities rises, so does the tax an investor pays on it. This could affect the long-term behavior of investors who don’t want to see increased returns on the front end and a large tax liability on the back end.
Prices That Are Slow To Budge
Some prices are quicker and easier for a business to change like gas prices which change daily. Meanwhile, superstores with thousands of items may take longer to reflect price changes as the store is tasked with updating numerous prices throughout the store and across multiple locations. So even when the prices of some items seem to decrease due to frequent updates, the prices of other goods could remain high despite a decreased value. These distorted prices extend the time and effort needed for consumers to successfully sort through purchasing decisions.
The burden of dealing with inflation could extend throughout the financial fabric of society and the economy. As Americans attempt to adjust their wages, buying behaviors and cash flow to accommodate increased prices, the market shifts again in response while slower-moving entities try to catch up.
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