3 negative impacts of inflation – Forbes Advisor

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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, indicated that prices rose 9.1% during the last year.

The report continues a high inflation trend which started last year. In 2020, the annual inflation rate was 1.2%. In 2021, it was 4.7%.

But what does this still high inflation mean? And is anyone actually taking advantage of the 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 they did, say, a year ago.

When everyone pays more and gets less for it, it can have profoundly devastating effects on the economy – and some people suffer 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,” says Jeanette Garretty, chief economist at Robertson Stephens, a San Francisco-based wealth management firm. “Ultimately, high inflation seeps into the nooks and crannies of every balance sheet and income statement.”

Here are a few reasons why inflation can be so devastating to everyone’s bank accounts.

3 ways inflation hurts consumers and the economy

1. Less purchasing power

The most obvious impact of inflation is that it hurts your purchasing power. If you can’t buy as many goods and services as before inflation, your quality of life will eventually decline.

“The essentials will take precedence over the non-essentials as everyone tries to stretch the buy side of their budget,” says Angelo DeCandia, a business professor at Touro University. “Think more money spent on groceries and gas, and less spent on travel and entertainment.”

The decline in purchasing power is really hurting families who already experiencing financial difficultiessays Dan North, senior economist at Allianz Trade, a trade credit insurer.

“Inflation hits lower-income families the hardest, because items like gas and food take up a much larger portion of their budget, leaving less for discretionary spending,” North said. . “So, for example, where they had money to go out to dinner, even fast food, or [go to the] movies once a month, now they won’t at all.

And if you’re already stretching your budget to the limit, it’s harder to make adjustments to keep your costs down. For example, if you’re already using the cheapest toilet paper or paper towel on the shelf, you can’t compromise.

In fact, a 2021 study from the University of Pennsylvania found that low-income households had to spend about 7% more on goods and services last year compared to 2019 or 2020, while high-income households had to spend 6% more. Recall that the annual inflation rate for 2021 was 4.7%.

2. Less savings

If rising prices for basic necessities are eating into your budget more than normal, you’re probably not putting as much money into a savings account. A June 2022 Forbes Advisor-Ipsos survey found that 42% of respondents were saving less money than usual.

“Inflation makes all of our income and savings less valuable,” says Todd Steen, professor of economics at Hope College in Holland, Michigan.

If you aren’t able to save as much as you used to, you may be less prepared for financial emergencies, which will force you to rely on expensive credit cards or loans to pay unexpected bills.

And even if you already have money in savings, this drop in purchasing power means your emergency fund might not stretch far enough to cover a financial crisis during a time of inflation.

If you have $1,000 set aside for a rainy day, you’d definitely be better off not having it. But here’s an example of how inflation can eat away at the value of your savings.

Auto repair prices increased by 9% from June 2021 to June 2022 according to CPI. If you had a $900 car repair in June 2021, in June 2022 that same car repair would have been $981. Suddenly, your saved $1,000 is worth a little less.

And this trend could continue for some time, according to Steen.

“Inflation is a difficult problem in an economy to eliminate, because when prices rise, workers want higher wages and salaries to keep up,” he says. “This may lead to future price increases, and the cycle continues.”

3. Loss of goods and services

Some industries do quite well in times of inflation, especially those where you can’t put spending on hold indefinitely, such as supermarkets, gas stations, and funerals, but some businesses are completely devastated.

Indeed, when inflation is galloping, consumers spend their money on products and services that they absolutely need and retain what they do not need.

You will get your car repaired if you need it. You will continue to spend money on food.

But you might not take your kids to a trampoline park. You could instead opt for a free urban playground with youngsters. Such decisions are understandable when prices are high, but collectively they can hurt segments of the economy.

“It could mean your favorite pizzeria closing its doors or your nail salon dropping a service because it has become too expensive,” says Callie Cox, investment analyst at eToro, a social investment and multi-brokerage firm. active with 10 offices around the world.

Is inflation eventually going down?

Yes, inflation will eventually come down.

Economists want inflation to stabilize, so that prices stabilize or rise gradually over time.

If prices fall sufficiently, if inflation drops below 0%, we speak of deflation. Deflation comes with its own list of negative effects – when customers don’t buy products or services, business owners may lower prices to be more competitive, but they may also need to lay off workers. workers.

Deflation can lead to a recession, which occurs when the economy contracts 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 it did during the Great Depression. For an example, consider that between 1929 and 1932, real estate prices in New York dropped 67%.

Falling prices sound great in theory, but if you don’t have a job and barely have any money, even cheap things will be too expensive.

The US central bank, the Federal Reserve, never wants inflation to fall too low – or rise too high. The sweet spot is considered a rate of 2% annual inflation rateallowing households and businesses to continue spending (and saving) as prices gradually rise over time.

If inflation is above 2%, the Fed will typically raise the fed funds rate (which causes interest rates to rise) in an attempt to slow the growth of the economy and reduce inflation. If inflation is below 2%, this will often lower interest rates, to encourage consumers to borrow money (for example, to buy a new car or a new house), which tends to run the economy.

What’s next for US inflation?

It’s hard to say what the next step is. The Federal Reserve has already raised 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 it carries some risk of entering a recession. A recent Reuters poll of economists determined that the country has a 40% chance of entering a recession.

If inflation continues to run wild, DeCandia says education and career choices could start to change.

“We’ve all heard the story of grandfather having to drop out of school to help support the family,” he says. “Could this become a new reality with sustained inflation? Even if it were to be less dramatic, the impact of higher inflation could alter the educational path of young people in several ways.

“In some cases, it can even eliminate dreams of higher education,” DeCandia says.

DeCandia also says that some people may be more likely to pick the job with the highest salary and put some of the other extras in, like personal growth in your career-next to.

If consumers change their education or career plans to survive high inflation, it could be detrimental to their long-term financial health.

If people struggle to save for a long time, it can be harder to plan to buy a house, save for vacations or send the kids to college, DeCandia says.

“For some people, the very idea of ​​owning a home may have to be put on the back burner,” he says.

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