If we look back in time at the amount of money our parents, grandparents and great grandparents were paying for items like candy, clothing, cars and even houses, we will notice that those prices seem unbelievably low as compared to today’s rate. The rising of prices over time is due to a little something we like to call inflation.
Many of us know what inflation is in a broad sense, but getting a better understanding can prepare us in terms of handling our finances. This article will take an in-depth look at inflation so you can stay on top of your financial situation.
What is Inflation?
In an economic sense, inflation is an increase in price and a fall in the purchasing power of currency. It means that just about everything you do, from getting gas, to buying groceries to getting a haircut, will go up in cost over time. By reducing the value of the dollar, inflation can reduce your standard of living.
What Causes Inflation?
There are two main factors that cause inflation. One is demand-pull.
Demand-pull occurs when the demand for a product exceeds the supply. Buyers are willing to pay more money to get the product so the price increases.
Another factor is cost-push inflation. This commonly occurs in natural disaster situations when demand remains the same but supplies run low. For instance, when Hurricane Katrina occurred, there was a gas shortage. Even though the demand remained the same, the low supplies caused the cost to increase.
Some say there are other factors that can affect inflation. One of these is money supply. A misinterpretation of the theory of monetarism, this is said to occur when the government prints out too much money. As a result, there is too much capital chasing too few goods which in turn triggers demand-pull or cost-push inflation.
Built-in inflation is another factor to consider. People expect prices to go up and labor expects a continuing increase in wages. Higher wages raise the cost of production, which raises the cost of goods resulting in a never-ending spiral.
How Do You Calculate Inflation Rate?
The inflation rate is the percentage of the increase or decrease in prices that occurs over a specific amount of time. So if the inflation rate for gas is 2% per year, you can expect gas to cost 2% more this year than it did this year.
If inflation rates exceed 50% a month, it’s considered hyperinflation. If inflation occurs during a recession, it’s called stagflation. Rising prices on assets like housing, gold or stocks are called asset inflation.
The inflation rate is an important component of the misery index, which is an indicator that helps determine the average citizen’s wealth. The unemployment rate also contributes to the misery index. When the misery index is over 10%, it means there is a recession, galloping inflation or both.
Examples of Inflation from Recent History
In the past, there have been many times when inflation has had a substantial effect on the economy. Here are a few examples:
- After World War I, prices in Germany went up by 29,500% in the month of October 1923. Germany wasn’t the only country that experienced hyperinflation during this time but they were hit the worst. Poland was also affected with 275% price increases.
- After World War II, Hungary experienced 207% inflation every day with prices doubling every 15 hours.
- After the Cold War, inflation hit hard all over the world. Russia, Ukraine, Bosnia and Armenia all saw increases ranging from 245-428% per month. However, none of these countries experienced inflation quite like Yugoslavia. The country saw a price increase of an astonishing 313,000,000% in January of 1994.
Minimum Wage Adjusted For Inflation
Although inflation can hit pretty hard, there are measures taken to counter these cost increases and one is the raising of the minimum wage.
President Franklin Roosevelt first set minimum wage in 1938 at 25 cents an hour. Adjusted for inflation, that would be $4.45 today.
Throughout history, Congress has raised minimum wage 22 times.
Today, cities and states have the option of setting their own minimum wage. As of January of 2019, 29 states had a minimum wage set above the federal level of $7.25 an hour.
Deflation Vs. Inflation
Although prices tend to rise, they can also go down. This phenomenon is known as deflation.
Deflation occurs when too many goods are available and people don’t have the money to pay for them. As a result, prices decrease.
Although deflation may seem like a good thing, it’s bad for the economy overall. For instance, if a particular type of sneaker becomes popular, retailers may start ordering it until they have more than they can sell. In order to sell the item, they must cut costs, which can lead to layoffs.
When people are unemployed, they can’t afford to buy goods and the cycle continues.
When credit providers detect a decrease in prices, they are likely to reduce the amount of credit they offer. This creates a credit crunch where consumers can’t access loans to purchase big-ticket items, which further affects business’s bottom lines and brings down the economy even more.
Inflation can be harmful to the economy but you can beat it by increasing your earnings and making smart investments, which will outweigh its effects. If you are able to increase your income by a percentage that is larger than the inflation rate, you are in good shape.
Some good investments include the stock market, Treasury Inflated Protected Securities and Series I Bonds. It is a good idea to do some research to find out how these options will work for you.
Now that you know a bit about how inflation works, hopefully you can do some financial planning to counter its effects. Good luck keeping things afloat in difficult times.