Inflation has been on the rise in recent months, which means that more and more people are paying more money to buy the same amount of goods and services they bought before. Prices are rising, in other words, but why? The Federal Reserve Bank made some decisions that resulted in interest rates going up, which led to higher inflation in the cost of goods and services, but it’s not necessarily all bad. Let’s take a look at what inflation really means, how it works and whether it’s something you need to be worried about or not.
How inflation works
In theory, inflation is fairly simple. In an economy, prices are determined by supply and demand. This means that if lots of people want something, they will have to pay more to get it. And if fewer people want something, then they will have to pay less (or even nothing) to get it. Think of how expensive concert tickets can be when popular bands come out with new material; or how much cheaper they were two years ago when no one wanted them anymore. The same thing happens with everything from coffee beans to oil costs and beyond; supply and demand can cause those prices – and any costs associated with them – go up or down. But what about inflation? How does that work? Simply put, inflation occurs when there is too much money in circulation. When there’s too much money in circulation, prices rise because everyone has more cash to spend. If you think about it, inflation actually makes sense: if there’s $100 in your pocket but $10 in someone else’s pocket, both of you are going to bid up the price of goods until they cost $10 each. Then you still only have $100 total between you but things cost twice as much as before!
Where does inflation come from?
The most common cause of inflation is an increase in aggregate demand. This can come from either consumption or investment, but what matters is that you are asking firms to produce more stuff than they previously were, says Murphy. For instance, if consumers decide they want to buy another TV because they just got a bonus at work, that’s an increase in aggregate demand. On the other hand, if firms think people will be willing to pay more for their goods—perhaps because of increasing optimism about their product—then those firms might start producing more and employing workers at higher wages. That increases costs of production (i.e., inflation) by putting upward pressure on labor costs.
The factors affecting rising prices
Prices are rising and that’s good news if you’re a business owner looking to increase revenues, but it can be bad news if you’re someone looking to buy more goods or services. So what factors might be causing prices to rise – and how does it impact both businesses and consumers? Inflation occurs when there is too much money in an economy for there to be enough goods and services to purchase, which naturally leads to price increases. The key question right now is why prices have been increasing so quickly over the past few years. There are four main reasons why inflation has taken off as fast as it has:
1. A strong economy—with low unemployment rates, high consumer confidence and steady GDP growth.
2. Rising wages—which means workers will have more disposable income to spend on goods and services.
3. Higher commodity prices—including oil, gas, food products and metals (like copper).
4. Interest rate hikes by central banks around the world. As interest rates rise, they make holding cash less attractive since people will earn more interest from their savings accounts instead of just keeping their cash under their mattress. When interest rates rise, investors look for other investments that pay higher returns than bank accounts; stocks often become one of those options because companies generally offer higher dividend yields than bank accounts do (meaning investors receive dividends from stocks instead of interest payments). This means investors need to sell some of their stock holdings in order to raise cash to meet these new financial obligations.
Who benefits and who suffers from inflation?
When rates are low, savers are at a disadvantage and borrowers benefit. For example, those holding government bonds could see their purchasing power eroded over time as inflation rises. So if you have money that you plan to keep in cash or short-term bonds, it’s important to take inflation into account when planning your spending. Savers must make sure they can beat inflation by investing in riskier assets—like stocks—that may pay off over time. If they don’t, they might find themselves earning very little interest from their savings accounts and CDs.
How can you protect your finances from inflation?
First and foremost, you want to make sure you’re fully prepared. Everyone has different resources and financial situations, so it might be hard to determine where to start—but there are some simple things everyone can do. While these tactics won’t stop inflation in its tracks, they can help prevent your finances from being adversely affected. Here are some ways you can help protect your wealth from inflation while we wait for interest rates to go back up again .
1. Pay off high-interest debt. Most credit card companies charge between 15%–25% interest per year, which means that carrying high-interest debt is very expensive. For example, if you have $5,000 in credit card debt at 25% interest with a minimum monthly payment of $100, it will take more than four years to pay off that debt at a cost of more than $3,300 in interest alone! So how can paying down your debt save money? Well, when you pay down your debt, it frees up cash flow to put toward other investments or expenses. Plus, as an added bonus, you may also see lower interest rates once your credit score improves.
2. Build an emergency fund. A large emergency fund (ideally enough to cover three months’ worth of expenses) is important because unexpected expenses can quickly add up and throw a wrench into even the best budgeting plans. The more savings you have available for emergencies like car repairs or home improvements , medical bills , or job loss , the less likely it is that any one expense will sink you financially . And having a safety net in place makes those inevitable bumps in life less stressful too!
3. Start saving for retirement. If you haven’t started saving yet, now’s a great time to get going. Your employer probably offers a 401(k), 403(b), 457(b), Thrift Savings Plan, or another type of retirement plan that allows you to set aside pre-tax income for retirement. Make sure you’re taking advantage of all your company’s benefits—and don’t forget about traditional IRAs and Roth IRAs either! These accounts let you save outside of work and deduct contributions from taxable income (although not always). That means more money in your pocket today and tax savings tomorrow!
4. Invest. Saving your money in a savings account isn’t doing you much good. In order to keep pace with inflation, you need to invest your cash and earn a return that outpaces the rising costs of goods and services. Investing isn’t just for people who have a lot of extra cash lying around though; you can start investing even if you only have a little bit to spare. Consider opening an investment account with a discount brokerage firm such as E*TRADE, TD Ameritrade, or Scottrade. By setting up automatic deposits each month, you’ll never miss the money and it’ll be working hard to grow your portfolio until you need it.
