What is Inflation? (Plus How it Affects Your Budget)
Inflation is the rate that prices rise. Prices include goods (like milk) AND services (like taxi rides). Typically, the annual inflation rate in the U.S. hovers around 2%. This is generally considered healthy. So what is happening now, and why does it matter for normal people?
Spoiler: Inflation is going up, up, up. And in the short term, it’s getting real tough to buy stuff.
Below we’ll cover the basics of inflation, cost of living, purchasing power, and how it all affects your spending and saving. Be brave, and read on.
Ever heard your dad or grandpa tell stories about how a gallon of milk used to cost just $2? Well, the reason the average price is now $3.50 goes back to inflation.1 Inflation is partly to blame for the recent rising cost of everyday items. This includes things like toilet paper, peanut butter, and dog treats.
What else is affecting sudden price hikes this year? Possibly labor shortages, shipping costs,2 and general disruptions to the global supply chain. (Remember the shipping container that blocked the Suez Canal? Yeah. That one.)
But back to inflation.
Here’s what usually helps to measure inflation:
1. The Consumer Price Index (CPI)
- From the perspective of urban consumers.
- Measures the average price change of some basic goods and services over time.3
- Includes rent and imports like new cars and clothing.4
2. The Producer Price Index (PPI)
- From the perspective of the seller.
- Measures the average selling price change received by U.S. producers of goods and services.5
- Includes medical services paid for by employers or the government.4:1
Inflation works like this:
- Imagine you spent $100 for something 20 years ago.
- In May 2021, you would need $151.49 to buy that same item.6
Newsflash: Inflation can be good or bad.7 It just depends on how fast it goes up, how long it lasts, and where our money’s at in the short-term.
What’s the big deal?
Inflation has been in the news A LOT lately. That’s because the annual inflation rate in the U.S. is going up. Like, really fast. This is especially true when it comes to the cost of used cars and hotel prices.
Here’s how the annual inflation rate has looked recently:
- 1.9% in 2018
- 2.3% in 2019
- 1.4% in 2020
- 5% as of May 20218
The rate spiking to 5% in such a short time has some people concerned, including my personal bank. They keep sending me messages about how and why I should invest instead of relying on cash. Their overall message is “don’t panic,” but also…don’t NOT panic.
Aloha, higher cost of living!
One interesting thing that inflation does is raise the cost-of-living. The U.S. Bureau of Labor Statistics calculates this. They use the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The CPI-W takes into account the cost of buying food, clothes, etc.
Some employers give annual cost-of-living increases. People who get Social Security and Supplemental Security Income (SSI) also get cost-of-living adjustments (COLA) to help keep pace with inflation.
Here’s how cost-of-living adjustments are looking:
- 1.3% in 20219
- Possibly 4.7% in 202210
So what’s going DOWN? Purchasing power.
When inflation increases, our purchasing power goes down. In other words, our money could buy less things next month than it did last month. This is a huge bummer if you’re already strapped for cash. About that…
How does inflation affect my savings?
With costs going up, it’s important to think about what we can do with money we already have. Keep in mind that when we have high inflation, cash loses value. Also, interest rates we typically earn at the bank don’t keep up with inflation.
Here are some things we can do to protect our money from high inflation:
- Open a savings account with a high APY
- Consider a CD, mutual fund, or low-risk stocks11
- Look for a better-paying job
Survive high inflation
This year’s higher inflation is stressing out lots of people. And truthfully, inflation can be scary because it raises the cost-of-living and lowers our purchasing power. That means that our money loses some of its value. But we can take steps to combat high inflation and protect our hard-earned money. How? With a high-yield savings account, low-risk investments, and/or a better-paying job. Cheers to surviving!
- US Inflation Calculator. (n.d.) Milk Prices By Year And Adjusted For Inflation. Retrieved from: https://www.usinflationcalculator.com/inflation/milk-prices-adjusted-for-inflation/.
- Goldman Sachs. (n.d.) US Daily: The Inflation Boost From Supply Chain Disruptions: Here Today, Gone in 2022. Retrieved from: https://www.gspublishing.com/content/research/en/reports/2021/03/16/5c14bc84-c0bc-4c99-8a3c-ad6a5e15efb1.html.
- U.S. Bureau of Labor Statistics. (n.d.). Consumer Price Index. Retrieved from: https://www.bls.gov/cpi/questions-and-answers.htm.
- U.S. Bureau of Labor Statistics. (n.d.) Comparing the Producer Price Index for Personal Consumption with the U.S. All Items CPI for All Urban Consumers. Retrieved from: https://www.bls.gov/ppi/methodology-reports/comparing-the-producer-price-index-for-personal-consumption-with-the-us-all-items-cpi-for-all-urban-consumers.htm.
- U.S. Bureau of Labor Statistics. (n.d.) Producer Price Indexes. Retrieved from: https://www.bls.gov/ppi/faqs/questions-and-answers.htm#1
- U.S. Bureau of Labor Statistics. (n.d.) CPI Inflation Calculator. Retrieved from: https://data.bls.gov/cgi-bin/cpicalc.pl?cost1=100.00&year1=200105&year2=202105.
- Hawkins, L. (2021, May 13). What is Inflation, and is it Good or Bad? Retrieved from: https://www.nasdaq.com/articles/what-is-inflation-and-is-it-good-or-bad-2021-05-13
- US Inflation Calculator. (n.d.). Current US Inflation Rates: 2000-2021. Retrieved from: https://www.usinflationcalculator.com/inflation/current-inflation-rates/.
- Social Security Administration. (n.d.). Latest Cost-of-Living Adjustment. Retrieved from: https://www.ssa.gov/oact/cola/latestCOLA.html.
- Konish, L. (2021, May 12). Social Security’s cost-of-living adjustment could be higher next year. But that doesn’t necessarily mean the money will go further. Retrieved from: https://www.cnbc.com/2021/05/12/social-securitys-cost-of-living-adjustment-could-be-bigger-next-year.html.
- Ally Bank. (2018, May 02). How Inflation Impacts Your Savings and What You Can Do About It. Retrieved from: https://www.ally.com/do-it-right/banking/how-inflation-impacts-your-savings-and-what-you-can-do-about-it/.