Home » Inflation is surging: What that means for your finances

Inflation is surging: What that means for your finances

Inflation is surging: What that means for your finances

This dollar doesn’t go as far as it used to because… inflation. 


Nuthawut Somsuk/iStock/Getty Images Plus/Getty Images

From milk at the grocery store to the potential death of the infamous $1 New York slice, prices across the US are rising. This means your dollar can’t buy as much as it could a few months ago, and that’s a problem. 

The Consumer Price Index, a key indicator of inflation (defined as the sustained rise in the cost of living), has increased by 6.8% since last November and is now at the highest level since 1982. The rising prices of food and fuel have made the most significant contributions toward that increase. But, even excluding those categories, inflation climbed by 4.9% last month, the fastest pace since 1991. This kind of sustained and increased inflation may point to something more enduring. 

In response to this, the Federal Reserve — the government agency in charge of keeping inflation in check — is taking action. 

Federal Reserve Chairman Jerome Powell was nominated for a second term by President Biden in November, and he’s currently undergoing the confirmation process in the US Senate. During his confirmation hearing with the Senate Banking, Housing and Urban Affairs Committee on Tuesday, Powell assured Congress that, in addition to cutting back asset purchases, the Fed is prepared to raise interest rates in response to persistent inflation.

“The economy has rapidly gained strength despite the ongoing pandemic, giving rise to persistent demand and supply imbalances, bottlenecks and elevated inflation,” Powell said. “If we see inflation persisting at high levels longer than expected, if we have to raise interest rates more over time, we will.”

How inflation impacts you

Inflation isn’t inherently good or bad. When kept in check, it’s a sign of a healthy economy. It keeps us spending rather than tucking our cash under a mattress. Inflation rates have remained steady in recent decades, but now some commenters worry that current prices will keep climbing to the point where consumers are squeezed, undermining the economic recovery. And it may threaten labor market participation by messing with price stability, which the Fed is working to get back on track in the post-pandemic era.

“To get the kind of very strong labor market we want with high participation, it’s going to take a long expansion,” Powell said. “[Labor market] participation is moving very slowly. To get a long expansion we’re going to need price stability, and so in a way high inflation is a severe threat to the achievement of maximum employment and to achieving a long expansion that can give us that.”

Here are some key things you need to know about inflation, and how it can impact your budget and your spending power. 

What is inflation? 

Simply put, inflation is a sustained increase in consumer prices. It means a dollar bill doesn’t get you as much as it did before, whether you’re at the grocery store or a used car lot.

Inflation is usually caused by either increased demand — such as COVID-wary consumers being finally ready to leave their homes and spend money — or supply-side factors like increases in production costs. 

Inflation is a given over the long term, and it requires some historical context to mean anything.

For example, in 1985, the cost of a movie ticket was $3.55. Today, watching a film in the theater will easily cost you $13 for the ticket alone — never mind the popcorn, candy or soda. A $20 bill in 1985 would buy you almost four times what it buys today.

Over the past century, there have only been a few years when the annual inflation rate in the US has been a negative number. But we also measure inflation in the short term, where we can see sharper rises, such as the one we saw for June.

How do we know if we’re in a period of inflation?

Inflation isn’t a physical phenomenon we can observe. It’s an idea that’s backed by a consensus of experts who rely on market indexes and research. 

One of the most closely watched gauges of US inflation is the Consumer Price Index, which is produced by the federal Bureau of Labor Statistics and based on the diaries of urban shoppers. CPI reports track data on 80,000 products, including food, education, energy, medical care and fuel.

The BLS also puts together a Producer Price Index, which tracks inflation more from the perspective of the producers of consumer goods. The PPI measures changes in seller prices reported by industries like manufacturing, agriculture, construction, natural gas and electricity.

And there’s also the Personal Consumption Expenditures price index, prepared by the Bureau of Economic Analysis, which tends to be a broader measure, because it includes all goods and services consumed, whether they’re bought by consumers, employers or federal programs on consumers’ behalf. 

The Labor Department announced that the CPI increased by 5% in May, following an increase of 5% in April — the rise that first caused a stir among market watchers. Some specific market segments are experiencing even more dramatic price surges: The index for used cars and trucks shot up by 10.5% in June. 

But that rise in the CPI, in and of itself, doesn’t mean we’re necessarily in a cycle of rising inflation. That’s where the Federal Reserve comes in.

How the Federal Reserve can fix things

The Fed, created in 1913, is the control center for the US banking system and handles the country’s monetary policy. It’s run by a board of governors and is also made up of a Federal Open Market Committee, 12 regional Federal Reserve banks and 24 branches.

While the BLS reports on inflation, the Fed moderates inflation and employment rates by managing the supply of money and setting interest rates. Part of its mission is to keep average inflation at a steady 2% rate. It’s a delicate balancing act, and the main lever it can pull is to adjust interest rates. In general, when interest rates are low, the economy and inflation grow. And when interest rates are high, the economy and inflation slow. 

Back in April, the Fed noted that recent rises in inflation were “transitory” and attributed stronger economic activity and employment to progress with COVID-19 vaccinations and related policies. Federal Reserve Vice Chairman Richard Clarida said prices “are likely to rise somewhat further before moderating later this year” and warned that they might even exceed its 2% rate goal. But he called them “one-time increases.” It seems, however, that may not be the case, since inflation continues to accelerate. 

With rates well over the 2% inflation goal, many expected the Fed to increase interest rates in November, and perhaps again in December, but interest rates remained untouched through 2021. However, the majority of Fed officials see at least three interest rate hikes coming in 2022 in response to rising inflation.

Should we be worried?

Maybe, though it’s too soon to say. While you’re seeing the cost of day-to-day living go up, it’s possible it’s just the normal and expected response to the previously stalled-out pandemic economy, which is rapidly strengthening.

There’s been no consensus among experts that inflation will become a sustained cycle. It’s just on their radar, especially now with the rapid pace.

However, the accelerating pace of inflation — and the fact that it’s seeping into portions of the economy undisturbed by the pandemic — could mean the situation is worse than originally thought. For now, the Fed has decided to double its pace of tapering asset purchases by $30 billion monthly (double the amount announced in November), starting this month. One reason for doing so is to enable the Fed to increase interest rates sooner than originally planned if necessary. This would raise the costs of borrowing, which in turn could reduce the demand in the economy, helping to balancing the supply and demand scales (one cause of inflation). But cutting back on this bond-buying program will also have other consequences, like rising mortgage rates. 

It’s worth noting that the Fed has been generally successful in keeping inflation at or below its target of 2% for almost a decade. But these are unprecedented times, and this is definitely an issue to keep an eye on.

What about the other ‘flations’: Deflation, hyperinflation, stagflation?

There are a few other “flations” worth knowing about. Let’s brush up.

Deflation

As the name infers, deflation is the opposite of inflation. Economic deflation is when the cost of living goes down. (We saw this, for example, during parts of 2020.) Widespread deflation can have a devastating impact on an economy. Throughout US history, deflation tends to accompany economic crises. Deflation can portend an oncoming recession as consumers tend to halt buying in hopes that prices will continue to fall, thus creating a drop in demand. Eventually, this leads to consumers spending even less, lower wages and higher unemployment rates. 

Hyperinflation

This economic cycle is similar to inflation in that it involves an increase in the cost of living. However, unlike inflation, hyperinflation takes place rapidly and is out of control. Many economists define hyperinflation as the increase in prices by 1,000% per year. Hyperinflation is uncommon in developed countries like the US. But remember Venezuela’s economic collapse in 2018? That was due in part to the country’s inflation rate hitting more than 1 million percent.

Stagflation

Stagflation is when the economy enters a period of stagnation. In these instances, unemployment is high, prices are rising and economic growth is slow. Stagflation was first recognized in the 1970s after the energy crisis. Simultaneously, inflation doubled, the US experienced negative GDP growth and unemployment reached 9%. Memories of this dark economic time factor into current fears of inflation spiraling out of control, even though the circumstances are very different. 

Michelle Meyers and Justin Jaffe contributed to this report.