Most people understand that inflation is when prices go up. To be more precise, the International Monetary Fund defines it this way: “Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country (emphasis added).”
While many measures of economic activity can seem abstract and far removed from everyday life, inflation affects all of us in ways we can’t ignore.
American writer and humorist Sam Ewing captured this well when he wrote, “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.”
Inflation doesn’t just steal money from your paycheck and savings every time you go to buy things. It also reminds you of the changes that come with the passage of time. The $5 haircut is part of a bygone era.
Recently, inflation has been running at rates not seen since the early 1980s. Led by a huge short-term spike in gasoline prices, the Consumer Price Index (CPI), a broad measure of the cost of living calculated by the Bureau of Labor Statistics, rose more than 9% from a year ago. This recent increase is certainly higher than expected, especially in the wake of the Federal Reserve’s aggressive move to raise interest rates.
Economists agree that there are three major factors contributing to our current high inflation.
A short-term cause has to do with the aftermath of the pandemic. In the first year, while manufacturers were cutting back production in anticipation of an economic slowdown, consumers were given trillions of additional dollars in stimulus funds and extra unemployment benefits. When you have more money chasing fewer goods, prices tend to go up. This imbalance is still working itself out.
A middle-term cause has been the rise in wages. Several factors have caused a record number of people to quit their jobs. Unemployment is at a record low and companies have had to raise wages (their largest expense) to attract needed workers. This trend is continuing.
And finally, the rising cost of debt will put upward pressure on prices. For more than a decade it has been unthinkable for central banks to raise benchmark interest rates. This has meant that both governments and businesses have been able to service their debt at a very low cost. But as the Fed raises rates, the cost of borrowing will rise, putting pressure on public budgets and forcing businesses to pass along these higher costs.
Knowing that higher-than-usual inflation may be around for a while, what should you do?
First of all, as always, control the controllable. That means adjusting your spending habits, if necessary, to keep in line with your budget. And continue working toward your long-term investing goal. We can help you keep your plan on track.
Secondly, don’t worry about what you can’t control. Meaning, we often worry about future events based on speculation – as in the markets will stay down forever. They never do that, though there are periods of time when the most popular asset class will be down from its last high water mark. Worrying about what could go wrong only takes the joy out of the present. Focus instead on what you can control – behavior and how you react to things.