You might’ve been hearing about inflation in the news recently, but you’re not entirely sure what it is or how it affects you.
Well, we’ve got you sister. Here are 5 things you should now about inflation and its effects on your wallet and your investments.
1. What is inflation?
Inflation is a measure of the average price level of goods and services in an economy over time. It is calculated by taking the price of a basket of goods and services at two points in time and dividing the difference by the price of the basket at the earlier point.
Very simply put, if the price of a gallon of milk was $2.00 one year and increased to $2.50 the next year, the inflation rate would be 25%. This means that on average, prices have increased by 25% in that year.
2. What causes inflation?
Inflation can be caused by a number of factors, including increased demand and reduced supply. When demand for goods and services increases faster than the available supply, prices will rise as businesses try to maximize their profits. When supply is reduced, as can happen during a recession, the same effect happens as businesses compete for a smaller pool of goods and services.
Three factors that can also contribute to inflation are increases in the money supply, increases in government spending, and increases in taxes. When the amount of money in an economy increases faster than the amount of goods and services available, prices will go up as businesses try to make a profit. Similarly, when the government spends more money than it takes in through taxes, or when it raises taxes, that can also lead to higher prices.
3. How does inflation impact the economy?
When prices rise, people have less purchasing power. This can lead to a decrease in economic growth as people have less money to spend on goods and services.
In a high-inflation environment, businesses may lay off employees in order to stay profitable. This can lead to higher levels of unemployment as people lose their jobs and are unable to find new ones.
4. How can inflation be controlled?
Inflation can be controlled through a number of methods, including:
One way that the government can try to control inflation is by using monetary policy. This involves using interest rates and the money supply to influence economic activity.
For example, if the government wants to slow down the rate of inflation, it may raise interest rates. This will make it more expensive for businesses to borrow money, which will lead to less investment and slower economic growth.
Alternatively, if the government wants to stimulate the economy, it may lower interest rates. This will make it cheaper for businesses to borrow money, which will lead to more investment and faster economic growth.
One way that the government can use fiscal policy to control inflation is by increasing or decreasing government spending. When the government spends more money, it can lead to an increase in demand for goods and services, which can cause prices to rise.
Alternatively, when the government decreases its spending, it can lead to a decrease in demand and a decrease in prices. This is known as deflation. Deflation can be helpful in controlling inflation, but it can also lead to a decrease in economic growth and increased unemployment.
This involves taking measures to increase the amount of goods and services available in an economy.
Some common supply-side policies include:
- Reducing taxes on businesses: This will give businesses more money to invest in new products and services, which will lead to an increase in supply.
- Making it easier for businesses to open: This will increase competition, which will lead to lower prices and a greater variety of goods and services.
- Encouraging investment in new industries: This will help to expand the economy and create new jobs, which will lead to an increase in supply.
5. Should I avoid investing when inflation is high?
There is no one-size-fits-all answer to this question, as the decision of whether or not to invest when inflation is high will depend on a number of factors, including the overall economic conditions of the country and the specific industry in which you are investing. Generally speaking, however, investing during times of high inflation can be risky, as prices may continue to rise faster than the rate of return on your investment.
When inflation is high, one way to protect your investment portfolio is to invest in assets that are designed to hedge against inflation. These assets can include investing in real estate, or stocks in companies that are expected to benefit from rising prices.
Another option is to invest in bonds, which are loans that are made to governments or corporations. When inflation rises, the value of a bond’s fixed payments will increase, providing a hedge against inflation.
Need help navigating inflation?
It can definitely be confusing, but we’re here to help! Work one on one with us by booking a money coaching discovery call, or join us in the Money Bitch Facebook Community or Instagram to stay in the know.
We also recommend this podcast if you’d like to explore this topic even further.