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The latest inflation report piled bad news on top of bad news. The June Consumer Price Index (CPI), which the Bureau of Labor Statistics uses to track price changes for 80,000 goods and services, showed prices rose 9.1% over the past year.
The report continues a trend of high inflation that started last year. In 2020, the annual inflation rate was 1.2%. In 2021 it was 4.7%.
But what does this persistently high inflation mean? And does anyone actually benefit from high prices?
What is inflation?
Simply put, inflation is an economic term used to describe rising prices.
Inflation occurs when people spend more on the same amount of goods and services than, say, a year ago.
When everyone pays more for less, it can have some profoundly devastating effects on the economy — and some people get hurt more than others.
“In every economic environment there are winners and losers, and inflation is no exception. However, the longer high inflation persists, the harder it is to find winners,” said Jeanette Garretty, chief economist at Robertson Stephens, a San Francisco-based wealth management firm. “In the end, high inflation seeps into the nooks and crannies of every balance sheet and income statement.”
Here are some reasons why inflation can be so devastating to everyone’s bank accounts.
3 ways inflation is hurting consumers and the economy
1. Less purchasing power
The most obvious effect of inflation is that it hurts your purchasing power. If you can no longer buy as many goods and services as you did before inflation, your quality of life will eventually decline.
“The essential will take precedence over the non-essential as everyone tries to stretch the buy side of their budget,” said Angelo DeCandia, professor of business administration at Touro University. “Imagine spending more on groceries and gas and less on travel and entertainment.”
Less purchasing power hurts families who were already struggling financially, says Dan North, senior economist at commercial credit insurer Allianz Trade.
“Inflation hits the lowest-income families harder because things like gas and groceries take up a much larger portion of their budgets and less is left for discretionary spending,” says North. “Like, where they used to have money to eat out, even fast food, right [go to the] to the cinema once a month, now not at all.”
And when you’re already pushing your budget to the limit, it’s harder to make adjustments to reduce your costs. For example, if you’re already using the cheapest toilet paper or paper towels on the shelf, you can’t save.
In fact, a 2021 University of Pennsylvania study found that low-income households spent about 7% more on goods and services last year compared to 2019 or 2020, while higher-income households spent 6% more. Remember that the annual inflation rate for 2021 was 4.7%.
2. Less savings
If rising prices for essentials are taking a bigger toll on your budget than normal, you probably aren’t putting that much money in a savings account. A June 2022 Forbes Advisor-Ipsos survey found that 42% of respondents are saving less money than usual.
“Inflation makes all of our income and savings less valuable,” says Todd Steen, an economics professor at Hope College in Holland, Michigan.
If you can’t save as much as you used to, you may be less prepared for financial emergencies and have to rely on expensive credit cards or loans to pay off unexpected bills.
And even if you already have savings, that reduced purchasing power means your emergency fund may not be enough to cover a financial crisis during an inflationary spell.
If you’ve got $1,000 saved for a rainy day, you’re certainly better off than not having it. But here’s an example of how inflation can eat away at your savings.
Auto repair prices increased by 9% from June 2021 to June 2022, according to the CPI. If you had a $900 car repair in June 2021, the same car repair would have cost $981 in June 2022. Suddenly, your $1,000 savings are worth a little less.
And that trend could continue for a while, according to Steen.
“Inflation is a difficult problem in an economy to fix because when prices go up, workers want higher wages to keep up,” he says. “This can lead to future price increases and the cycle continues.”
3. Loss of Goods and Services
Some industries do pretty well during inflationary times, particularly those where you can’t hold back spending indefinitely like supermarkets, gas stations, and funerals — but some companies are utterly devastated.
Because when inflation is rampant, consumers spend their money on products and services they absolutely need and hold back on what they don’t need.
They will have your car repaired when you need it. You will continue to spend money on food.
But maybe you don’t take your kids to a trampoline park. You could opt for a free city playground with the youngsters instead. Decisions like these are understandable when prices are high, but overall they can hurt parts of the economy.
“It could mean your favorite pizza place is closing or your nail salon is closing a service because it’s gotten too expensive,” says Callie Cox, investment analyst at eToro, a social investment and multi-asset brokerage firm with 10 offices worldwide.
Will inflation ever go down?
Yes, inflation will eventually decrease.
Economists want inflation to stabilize so that prices either level out or gradually increase over time.
When prices fall far enough where inflation falls below 0%, it’s called deflation. Deflation has its own negative effects — if customers aren’t buying products or services, business owners can lower prices to be more competitive, but they may also have to lay off employees.
Deflation can lead to a recession, which occurs when the economy shrinks instead of growing.
Read more: Is the US economy headed for stagflation?
Deflation can also contribute to a depression – which is more severe than a recession – as was the case during the Great Depression. For example, imagine that real estate prices in New York City fell 67% between 1929 and 1932.
In theory, falling prices sound great, but when you’re unemployed and tight on money, even cheap stuff becomes too expensive.
The US Federal Reserve never wants inflation to fall too much – or rise too much. The sweet spot is considered to be a 2% annual inflation rate, which allows households and businesses to continue spending (and saving) as prices gradually increase over time.
Generally, when inflation is higher than 2%, the Fed raises federal funds rates (resulting in higher interest rates) to try to slow the growth of the economy and lower inflation. When inflation is below 2%, interest rates are often lowered to encourage consumers to borrow (say, to buy a new car or house), which tends to keep the economy humming.
What’s next for US inflation?
It’s hard to say what’s coming next. The Federal Reserve has hiked interest rates several times this year and is expected to do so until the fed funds rate hits 3.5%. This is expected to push prices lower, but there is some risk of entering a recession. A recent Reuters poll of economists found that the country has a 40 percent chance of sliding into a recession.
If inflation keeps running amok, DeCandia says education and career choices could change.
“We all know the story of how grandpa had to drop out of school to support the family,” he says. “Could this become a new reality if inflation continues? Even if it were less dramatic, the impact of higher inflation could alter educational trajectories for younger people in a number of ways.”
“In some cases, it can even eliminate grad school dreams,” says DeCandia.
DeCandia also says some people are more likely to choose the highest-paying job and put aside some of the other extras — like personal fulfillment in your career.
If consumers change their education or career plans to weather high inflation, it could be at the expense of their long-term financial health.
When people struggle to save over a long period of time, it can become more difficult to plan for a home purchase, save for vacations, or send kids to college, DeCandia says.
“For some people, the whole idea of owning a home may have to be put on hold,” he says.