Understanding inflation and rising prices

We’ve all heard a lot about inflation over the last year or two. Even if you’re not totally sure what inflation really means (and don’t worry, you’re not alone), you’ve probably gotten the feeling that it’s no laughing matter.

If you have questions about inflation, read on to get the answers you need. Then, we’ll see if there’s anything we can find to smile about during tough economic times.

What exactly is inflation?

Inflation is defined as “overall general upward price movement of goods and services in an economy.” This is usually due to a combination of higher production costs, increased consumer demand (but lower spending power) and a range of fiscal policies.

So, this is what’s been happening in the U.S.?

Yes. Back in March of 2022, the government announced that the Consumer Price Index (CPI) rose 8.5% from a year earlier. This was the highest increase since 1981, which was a period of peak inflation. Throughout the year, inflation continued, and while it’s a little lower right now, it may rise again in 2023.

Wait, what’s the CPI?

The CPI is a “measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.” In other words, it’s a gauge of inflation based on what it costs you at the grocery store or when you fill your gas tank, for example. The CPI is released every month by the Bureau of Labor Statistics.

Has there ever been inflation like this in the past?

Yes, but Stanford economist John Taylor says there are some unique characteristics of our recent market conditions. What’s different today is how fast and strong inflation came on.

In Stanford University news he explained, “The inflation rate, as measured by the percentage change in the consumer price index, jumped from 1.4% in the 12-month period from January 2020 to January 2021 to 9.1% in the 12-month period from June 2021 to June 2022. The last time inflation in the United States moved by such a large amount was in the 1960s and 1970s. But the situation was much different then: it took over 12 years, not just a year, for inflation to rise by large amounts.”

Now that inflation has been rising, how do we make it stop?

While seemingly counterintuitive, raising interest rates has historically been the main way the U.S. government tames inflation. It ultimately worked in the late 1970s and early 1980s. When rates go up, it becomes more expensive to borrow money, and that slows down spending — less demand, lower prices.

I heard the word “stagflation” the other day, and it seemed totally made up. Is it real? How is it different from inflation?

When discussing inflation, you may hear other similar terms, including high inflation, stagflation, deflation and hyperinflation.

Policymakers generally agree that 2% is an acceptable rate of inflation. High inflation is usually defined as inflation significantly beyond that, such as 10%. This may be caused by an increase in the money supply, but it can also be caused by an increase in demand for goods or by a decrease in supply. High inflation can be damaging to an economy on its own, and it can lead to stagflation, which is a combination of high inflation, high unemployment and stagnant demand.

Simply put, deflation is the opposite of inflation. It’s when prices drop and purchasing power rises. It can also be called negative inflation and is often considered to be harmful to an economy because it can lead to recession or depression.

Hyperinflation is extremely high inflation, at a rate of more than 50%, that often leads to the collapse of a currency. Hyperinflation can be caused by a huge increase in the money supply, but it can also be caused by a massive decrease in tax revenue or by an overwhelming government debt burden.

So, while the current level of inflation in the U.S. isn't optimal, it’s still far from being the worst thing that can happen. Inflation is definitely higher than before, but we are nowhere near hyperinflation.

Okay, yikes. How does inflation affect my savings?

One way to protect yourself from inflation is to invest in high-yield savings accounts or bonds, which are considered conservative but often outperform other types of investments when inflation is high. Central banks typically raise interest rates when inflation is a concern, so keeping your money in a high-yield savings account may help you stay ahead of the curve.

It’s starting to feel like inflation is nothing but trouble. Is there anything good about it?

The rising prices of inflation can sometimes lead to higher wages for workers who need salary increases in order to pay for necessities. However, there’s a cycle here: higher wages result in increased costs for businesses, which may eventually be passed on to consumers — in the form of even higher prices.

Ultimately, inflation affects most people in a negative way because they have to pay more for goods and services than they did in the past. And again, when inflation is high, it can reduce the purchasing power of people’s savings. Fortunately, there are steps that people can take to minimize the impact of inflation on their finances.

Got it. What should I keep in mind to limit inflation’s impact on my money?

Inflation is a fact of life, but it’s important to stay wary during periods of high inflation. Here are three things to watch out for:

1. Inflation can eat into your savings account.
   A high-yield savings account can be a great way to keep your money safe and earn more interest. Rates may change frequently, so check regularly and plan accordingly.
2. Inflation can affect your investment portfolio.
   In general, certain types of stocks tend to do well during periods of low inflation, but they can suffer during periods of high inflation. If you’re worried about how high inflation might affect your investments, speak to a financial advisor. They can help you create a diversified portfolio that will better weather economic storms.
3. Inflation can vary from country to country.
   If you’re traveling abroad, make sure to research the local inflation rate so you know what to expect. For example, countries like Venezuela and Argentina have been experiencing very high rates of inflation in recent years, so it’s important to budget accordingly if you’re planning a trip there.

Alright, what’s the one thing about inflation that we can laugh about?

As prices rise and prices fall (and rise again), it might not hurt to keep a sense of humor about the whole thing. We’ve seen people across the internet make some pretty great jokes about inflation.

When we’re dealing with circumstances beyond our control, like inflation, once we’ve done everything we can to protect ourselves and our investments, sometimes the next thing we can do is laugh. After all, laughter is often said to be the best medicine. According to the Mayo Clinic, it has both positive short- and long-term effects on your mental health.