Inflation is making headlines in 2022. Financial forecasters predict it may affect the economy into 2023 or beyond. Inflation may seem like a distant and abstract economic phenomenon, but it can have very real impacts on your daily life. It can upset everything from the prices you pay at the grocery store to your long-term financial security. Read on for answers to common questions about this price burst and how you can prepare yourself.
What is inflation?
Put simply, inflation happens when there’s continued growth in the prices of goods and services. Higher prices mean your dollar won’t go as far tomorrow as it did in the past, and your purchasing power decreases.
It’s common for prices to fluctuate for short periods — and, by extension, for your bank account balance to pay for less. For example, if a popular celebrity touts a hearty salad and shoppers rush out for ingredients, the price of kale may rise because of increased demand. Those minor fluctuations are normal and expected. These variations only earn the label “inflation” when they become widespread and occur over time.
Two gauges track these changes: the Consumer Price Index, which measures what consumers pay for a range of goods including food, cars, and energy; and the Personal Consumption Expenditures Price Index, which measures things people consume, such as health care.
Some inflation is normal. That’s why workers often receive 2% pay raises a year; those increases are meant to track with inflation. In December 2021, however, the CPI was up 7% and the PCE rose 5.7% — that’s the largest 12-month increase since 1982 for both indexes.
Inflation snowballs quickly. When prices go up, nervous consumers purchase more to avoid future price increases. That growing demand only spurs further price increases. Additionally, when workers find their wages aren’t going as far, they tend to ask for raises. With more money in their pockets, they purchase more, which adds fuel to the inflation fire.
What caused this inflation?
In general, inflation occurs when economies are flooded with spending. However, in 2022, unique factors have collided to create inflation.
In 2020, the novel coronavirus blew out the candle on the global economy. It was the harshest economic contraction ever recorded. The U.S. federal government passed the $2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES) to spark the economy. With stimulus checks in their accounts, people had money to spend, but supply didn’t recover as quickly. That demand drove up prices on new cars, fridges, and a variety of other products.
How does inflation affect the housing market?
The cost of housing is increasing. From 2020 to 2021, the CPI tracked a 4.1% increase in shelter prices, which accounts for rent and owners’ equivalent rent (what owners theoretically pay were they to rent their home). Home prices are also rising. At the end of 2021, they had risen 19.08% from the previous year. That makes it a good time to sell your home — and a less favorable time to buy.
There are three pieces of good news for home buyers. First, homes are thought of as a hedge against inflation because their value has traditionally kept pace with inflation. Second, if you lock in a mortgage with a fixed-interest rate now and inflation continues, you’ll feel like you’re spending less over time. Finally, interest rates will be rising soon as a check against inflation. It’s about to become more expensive to borrow. Homebuyers locking in rates now will save on interest over those who delay.
How does inflation affect the car buying market?
Car prices have increased dramatically. In 2021, the CPI tracked a 37.3% price increase in used vehicles and a 11.8% increase in new vehicles. You’ll likely have to adjust your buying criteria accordingly and expect to pay more for less value. With greater demand and less supply, you may also have to brush up on your negation skills. As in the home buying market, however, rising interest means this is still a good time to lock in rates.
How does inflation affect my financial future?
With inflation in play, you may have to save more toward retirement than you might expect to account for the decline in spending power. For example, if your current quality of life requires $3,000 a month, you may want to plan on spending $4,000 a month when retired. Saving more now might be difficult because inflation is also demanding you spend more on essentials. Budgeting is essential.
With these answers to common questions about inflation in hand, we hope you feel better informed and empowered to make the best financial decisions for you.