What you should know about inflation

Financial Tip Friday | 02/11/22
Young Couple at Desk Looking at Finances

What is inflation? What causes inflation? How is inflation measured? Find the answers to these questions and many more.

What is inflation?

You’ve probably had this thought before when out shopping for groceries.

Hmm. That used to cost less. So did that. And that.

Welcome to your first step into the world of inflation. We don’t consider it inflation when we see a price increase for one good or item; however, when many of the things we buy rise at the same time and continue to rise, that is inflation—the ongoing increases in the general price level for goods and services in the economy over time.

How is inflation measured?

Plenty of ready-made calculators for financial inflation can be found online and they can be of great service to a shrewd operator who knows how to run those models for peak efficiency. It is always better to be aware of the underlying methodology to ensure accuracy with a clear understanding of the calculations. Mathematically:

Percent inflation rate = (Final CPI Index Value/Initial CPI Value)*100

Wait a second... CPI? What the heck is CPI?

The CPI (or Consumer Price Index) is a measure that examines the weighted average of prices of a basket of goods and services which fall under the description of “primary consumer needs.” They include transportation, food, and medical care. Changes in the CPI are used to assess price changes associated with the cost of living, making it one of the most frequently used statistics for identifying periods of inflation or deflation.

What causes inflation?

An increase in the supply of money is the root of inflation; in all such cases of money supply increase, the money loses its purchasing power, thereby causing consumers to spend more than they used to in order to obtain the same item.

Are there different types of inflation?

There are three different types of inflation—demand-pull effect, cost-push effect and built-in.

  • Demand-Pull Effect: This occurs when an increase in the supply of money and credit stimulates overall demand for goods and services in an economy to increase more rapidly than the economy's production capacity. This increases demand and leads to price rises. More demand=higher price.
  • Cost-Push Effect: This occurs as a result of the increase in prices working through the production process. When things cost more to make or deliver, the cost is passed on to the consumer.
  • Built-In Inflation: As the price of goods and services rises, wage-earners and wage-payers come to expect that they will continue to rise in the future at a similar rate. This requires higher costs or wages to maintain the current standard of living.

Can’t the country’s financial regulators control this?

They do! In the U.S., the Fed's monetary policy goals include moderate long-term interest rates, price stability, and maximum employment. Each of these goals is intended to promote a stable financial environment.

Price stability—or a relatively constant level of inflation—allows businesses to plan for the future with relative certainty about what to expect. The Fed believes that this will promote maximum employment, which is determined by non-monetary factors that fluctuate over time and are therefore subject to change.

Can inflation be a good thing?

Too much of anything can be a bad thing, and inflation is no different; while a small level of inflation encourages spending over saving, which boosts the overall economic health in a country, the cost-of-living increases often aren’t commensurate with the inflation rate. The flip side of the coin to inflation is deflation, which sees prices fall, demand reduced, businesses cut back on their supplies and reduce the workforce, which then leads to higher unemployment and wage deflation which is just as bad if not worse than inflation. So like most things, inflation is fine and even healthy in moderation.

Is there anything I can do to be proactive?

Diversification is key. Don't put all your assets into one type of investment. Invest excess cash into a portfolio that fits your timeline and investing goals. Overall, the best bet for protecting yourself is finding and employing a sound financial strategy, which you can construct through your own research or make it easy on yourself and speak with an Ascend Retirement and Investment Services advisor.

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