how inflation impacts the economy and your financial well-being

Who Is Most Affected by Inflation's Effects on the Economy and Personal Finances?

If we simplify the definition of inflation, it is an increase in the expense of living followed by a loss in the value of money. When the prices of goods and services rise over an extended period of time, it usually indicates an inflationary scenario in the economy. Inflation measures how expensive products or services become, often after a year.

What are the effects of inflation on the economy?

Inflation can bring negative impacts on the economy as well as on your personal finances; check out how and every impact of inflation in detail;

1. Price rise: Inflation in the first position affects the prices to go up over time.

The amount you have today will buy you different goods or services in the future.

Whether inflation is 2% or 4%, it will reduce the purchasing power and your ability to buy things. In the long run, it can even worsen the situation as if the inflation doubles, the prices will even rise more.

The government uses the Consumer Price Index to track the rate of inflation in the country. The Federal Reserve, which holds the more significant hand on the country's monetary policies and currencies, uses the PCE price index to monitor inflation.

2. Majorly impacts the lower-income consumer: As lower-income consumers typically spend a higher proportion of their income on necessities, they are majorly affected by the rise in inflation. It is also because they lose their purchasing power and have less to cushion against the loss.

The policymakers and monetary marketplace contributors particularly recognize middle inflation. In a way, they do not calculate the prices of food commodities and energy like electricity due to their unstable nature, as those commodities do not mirror the long-term inflation trend.

It is also confirmed that the lower income purchaser spends a massive share of their income on household budgets like food, energy, and other commodities, or even if the prices rise, there is no substitute for these requirements.

Also, inflation is hedged by way of real estate and similar properties, and the negative or low-income consumer does not own much property like real estate.

3. Increase in interest price: Inflation, to a degree, is ideal for the financial system, but it's critical to maintain it under control. Here, the government and Central banks are vital in keeping inflation beneath management.

If we look at the rate of countries, the important financial institution commonly tries to hold it under 2% in developed countries, and for emerging economies, it's around 3% to 4%.

If the government and Central banks expect inflation to rise beyond the target, they increase the minimum interest rate.

This growth in interest rate makes borrowing extra steeply priced for ordinary people, which enables them to govern the quantity of cash inflow. There is a right-away connection between inflation and interest charges because while inflation increases, the interest charge tends to head up, too.

With a boom in interest rates, Central banks reduce the choice to take monetary risk and decrease the stress on charges, which allows the economy to run on course.

4. Inflation or stagflation: Inflation increases job opportunities and reduces the unemployment rate in the country. But it is good to balance inflation and unemployment because if inflation tends to rise for a more extended period, people can expect prices to keep going up to protect their jobs.

The same happened in the 1970s when the prices and wages kept increasing, resulting in stagflation.

To control the stagflation situation, the Federal Reserve raised the interest rate significantly for extended periods. This backfired and caused unemployment to go up for a longer time.

The situation of stagflation could not have occurred if the government had managed inflation and employment at the beginning.

Who benefits from high inflation?

1. Borrowers with fixed interest rates: Price in inflation and interest rate might not be good news for everyone, but still, there is a silver lining for those who have already bought with the fixed interest rate.

Inflation benefits those who had borrowed with a fixed interest rate.

Over a period, these borrowers benefit from lower interest rates as their monthly payments remain stable even as inflation increases the cost of living.

2. The Food Industry: The food industry has benefited from inflation. However, not all the industry players enjoy the rise in inflation, like restaurant owners.

On the bright side, poultry processors and food manufacturers have enjoyed the ride of inflation because food prices have increased by more than 10%.
Though there are various factors responsible for this rise, like the Russia-Ukraine war, the COVID-19 pandemic, etc., many food producers have enjoyed the increase in inflation as it is a necessity, and despite having a significant rise in the price, the demand for food products won't decline.

3. The Energy Industry: Food and energy are the two essential components majorly impacted by inflation. Despite having a considerable hike in their prices, the demand remains the same as they are counted as a necessity rather than a luxury.

Who is most hurt by inflation?

1. A consumer with a fixed salary: Inflation impacts those with a fixed income as inflation causes a rise in prices but not in income. This puts a strain on the budget and erodes the purchasing power of an income earner because prices go up faster than wages.

As of today, the federal minimum wage earner is most hurt by inflation because the minimum wage is at its lowest value in 70 years.
Inflation rose to a peak, but the wages have struggled to tackle inflation.

2. Renters: If you have your own house and pay a hard and fast interest rate against the loan, then you are on the secure facet; however, if you are a renter, your landlord will probably increase your lease in case of inflation. As the inflation is rising continuously, the rents also tend to rise with the inflation.

3. Investors in long-time period bonds: Excessive inflation poses a massive challenge for long-term bondholders.

And if you rely majorly on coupon bond payments, then you are really on the problematic side because the income from these bonds loses its value as the prices rise.
Interest rates and bonds have an inverse relation, and as the interest rates go up, the prices of the bonds go down. And therefore, the bondholders face a tragedy from inflation.
It is good to invest in inflation index bonds or series I, which are specifically designed to protect against inflation.

What are the three leading causes of inflation?

1. Cost-Push inflation: When the price of production cost increases with an increase in raw material and wages, the demand for goods remains the same while the supply of goods declines due to the rise in higher production cost, and the consumer pays the cost of production in the form of higher prices for the finish goods, then such situation causes inflation.

The most significant expense for business directly affects the cost of production. In a sound economy, the unemployment rate is generally low, which results in a shortage of labor or workers. To attract more work, companies start increasing wages, which causes an increase in production costs for the company. To cover the loss that has occurred by paying more salaries, companies directly increase the price of the product and service.

2. Demand-push inflation: Demand-push inflation: When demand for a service or product increases significantly, this excessive demand increases the expenses of these goods or services. However, it isn't always a trouble when the need is short-time as it is simple to balance with supply. It creates a problem when demand keeps going up and supply freezes.

Such a situation generally takes place when the unemployment rate is low, and wages keep on rising. People have extra money to spend, which also increases the purchasing power of the consumer. People in such situations willingly pay more for the product, which increases the demand for the product and results in demand-pull inflation.

3. Built-in inflation: In such a situation, people anticipate that the prices will keep increasing. When the cost of goods and services increases, people assume that prices will rise. Due to these expectations, they demand more wages to survive the inflation.

When the wages are paid in large quantities, businesses boom the cost of manufacturing, and in the end, the rate is passed directly to the customer. Higher salaries additionally suggest that consumer have extra cash to spend, which increases their purchasing power, and the demand for goods also increases. The cycle continues, which is called the wage-price spiral.

Bottom Line

Inflation is when the prices of goods and services increase over time. If there is an imbalance between the money supply and the Gross Domestic Product, it highlights inflation. The consumer price index measures it. Indeed, inflation is not a good sign for the economy, but a little bit of inflation shows that the economy is progressing. Also, various consumers benefit from high inflation. It increases the prices of stocks and other investments, genuine estate.