“Inflation” refers to a gradual rise in the price of goods and services in tandem with a decrease in the purchasing power of currency. In the U.S., inflation, as it relates to consumer goods, is measured by the consumer price index (CPI). In January 2022, the Bureau of Labor Statistics (BLS) reported a 7.5% increase in the CPI over the year. This was the most significant increase documented since 1982.
Reasons for Inflation
Many different factors can directly or indirectly affect inflation. However, there are some typical causes behind rising inflation and consumer prices.
Inflation and Economic Recovery
As counterintuitive as it may seem, economic recovery can prompt inflation, especially if the recovery is significant and over a relatively short period. This is usually caused by an increase in demand prompted by the greater prosperity of consumers.
For example, if the GDP grows as a result of increased production, more workers are likely required to meet production needs. As a result, unemployment will likely decrease and wages may rise. This in turn will likely result in higher demand for goods and services as consumers gain more spending power, and this greater demand may prompt price increases.
Weather and Climate Change
Climate change doesn’t only affect global temperatures. It inadvertently affects financial markets as well. As global temperatures rise, extreme weather events, such as wildfires and hurricanes, occur more frequently and with more intensity. One study found that 70% of reported extreme weather events were made more likely or more severe by climate change.
As climate change and extreme weather events continue to ramp up, it’s been shown to have increasing effects on the market, thus causing inflation. Here are just a few ways these events impact inflation:
- Destroying resources like crops and infrastructure;
- Interrupting work related to production and distribution;
- Damaging means of transportation;
- Changing priorities in the stock market;
- Needing to transition away from major contributors to climate changes that society is largely built around, such as fossil fuels;
- Needing to increase the cost of goods and services that contribute to climate change.
In general, climate change is prompting significant adjustments to economic policy, as well as impacting supply chains.
Supply Chain Bottlenecks and Inflation
A supply chain bottleneck is a point within a supply chain where the workload becomes so congested that it overwhelms the resources of that step in the process.
For example, a warehouse may receive more products that its employees can process efficiently, which can create a domino effect of problems and delays throughout the rest of the supply chain. This can create a scarcity of supplies available to consumers, which can in turn raise the value (and therefore prices) of the affected items.
Increase in Money Supply
Under some circumstances, a government may choose to “print” money to stabilize the economy or buy particular economic assets like banks. In the past, this has been used in a chain of events to establish the gold standard, but currently, most governments use this tactic in a virtual capacity.
However, this tactic can cause negative economic impacts as well because, generally speaking, the more money that is in circulation, the less valuable it becomes. As such, these measures typically result in inflation.
Effects of Inflation
Inflation can have far-reaching impacts on consumers, with some effects being obvious and expected while others may be more subtle and indirect.
Cost of Goods and Services
The most obvious effect of inflation is the increase in consumer goods and services. While inflation can be a reflection of the rising costs of goods and services as a whole, it can also impact particular products and services more than others. For example, poor weather conditions that affect crops may cause significant inflation in the food sector.
Interest Rates
Typically, interest rates rise alongside inflation rates. This is because interest rates are commonly used to offset inflation. When inflation rises too high, the U.S. Federal Reserve will raise interest rates in response.
Fixed-Rate Bonds
As the purchasing power of currency decreases, the value of older bonds will typically increase while the price of bonds decreases overall. This is largely a consequence of rising interest rates which make these existing bonds less attractive to investors.
How Do I Protect Myself From Inflation and Rising Consumer Prices?
While inflation trends are typically out of consumers’ ability to control, there are steps you can take to protect yourself from the effects. Overall, careful budgeting and diversification of your investments are the best ways that you can insulate yourself from rising consumer prices.
Precious Metals
As a valuable tangible asset, precious metals like gold and silver coins are a great choice for investors who are looking to insulate their finances from inflation. In a similar vein, financial assets backed by precious metals such as gold and silver IRAs can provide more security than cash-backed assets. If you choose to invest in precious metals, it is important to find a reputable institution to trade through.
Real Estate
Inflation can affect housing markets in a variety of ways. While it is not particularly advisable to buy real estate during a time of high inflation due to an increase in prices, it can be a valuable way to protect against future inflation. This is because the value of real estate rises along with inflation as a result of increasing demand related to labor and materials.
Long-term Stock Investment
Stock investments have the potential to provide returns that outstrip losses related to inflation. This is especially true of investments within stable industries, such as food and transportation.
Family Budget
When costs rise, you may have to reassess your budget and prioritize basic needs. It may also be a good idea to ensure that you have an emergency fund in place to address any unexpected expenses you encounter during times of financial insecurity.
