But inflation is a double-edged sword. Higher prices that consumers pay for goods and services may completely gobble up their extra savings. Consumer prices jumped 4. On one hand, that acceleration makes sense — a year ago, the Covid pandemic buckled the U. With the Covid threat waning, consumer demand along with some supply shortages is pushing up prices in certain sectors. The latter would generally lead the Federal Reserve to raise interest rates, in order to increase borrowing costs and, hopefully, keep the economy from overheating.
Rates on savings accounts, money-market funds and certificates of deposit, for example, would likely tick up — instead of being the equivalent of "mattress money" with practically no yield, according to Diahann Lassus , managing principal at Peapack Private Wealth Management in New Providence, New Jersey. Be sure to avoid costly Medicare mistakes How to avoid overspending in this hot housing market.
However, consumers might funnel those returns to living expenses like rent, food, transportation and health insurance if they swell in price, she said. Indeed, some companies have raised prices recently for household items like toilet paper, peanut butter and soft drinks.
There are a few times in history when savers derived a negative net return after accounting for inflation. In , for example, a benchmark year Treasury bond yielded an average However, a And that's before tax. In fact, a low-inflation, low-interest-rate environment like the pre-pandemic dynamic is optimal for consumers from a tax perspective, Roth said. That's because the U.
Meaning: People weren't spending. But now they plan to make up for lost time , as we discussed a few weeks ago. With that in mind, many economists and other financial experts say that the current rate of inflation is nothing to worry about — it's temporary and expected, even if it is unclear when it will eventually fade.
And today's increase is nothing compared with the s , when several unique shocks led inflation to hit double digits, says McCoy. However, there will be sticker shock this summer, says McCoy, as supply chains catch up with consumer needs post-pandemic. For the time being, here's how higher inflation could cost you and what you should do about it.
Inflation erodes the average person's purchasing power. Everyone's true inflation rate is different, because we all buy different products and services. You can expect to pay more for used cars and car rentals, furniture, airline fares, hotels and everyday essentials like groceries and gas.
Used car prices rose Housing and remodeling supplies are also sky high. That's no reason not to spend money, though, especially after the past 15 months, says Marguerita Cheng, certified financial planner and CEO of Blue Ocean Global Wealth. But that's no reason to move it around, especially your emergency fund, says Cheng. It's meant to provide a financial cushion, should you need it.
Unfortunately, the urge to spend and invest in the face of inflation tends to boost inflation in turn, creating a potentially catastrophic feedback loop. As people and businesses spend more quickly in an effort to reduce the time they hold their depreciating currency, the economy finds itself awash in cash no one particularly wants.
In other words, the supply of money outstrips the demand, and the price of money—the purchasing power of currency—falls at an ever-faster rate. When things get really bad, a sensible tendency to keep business and household supplies stocked rather than sitting on cash devolves into hoarding, leading to empty grocery store shelves. People become desperate to offload currency so that every payday turns into a frenzy of spending on just about anything so long as it's not ever-more-worthless money.
Note: By December , an index of the cost of living in Germany increased to a level of more than 1. As these examples of hyperinflation show, states have a powerful incentive to keep price rises in check. For the past century in the U. To do so, the Federal Reserve the U. If interest rates are low, companies and individuals can borrow cheaply to start a business, earn a degree, hire new workers, or buy a shiny new boat. In other words, low rates encourage spending and investing, which generally stokes inflation in turn.
By raising interest rates, central banks can put a damper on these rampaging animal spirits. Suddenly the monthly payments on that boat, or that corporate bond issue, seem a bit high. Better to put some money in the bank, where it can earn interest. When there is not so much cash sloshing around, money becomes more scarce. That scarcity increases its value, although as a rule, central banks don't want money literally to become more valuable: they fear outright deflation nearly as much as they do hyperinflation.
Another way of looking at central banks' role in controlling inflation is through the money supply. If the amount of money is growing faster than the economy, the money will be worthless and inflation will ensue. That's what happened when Weimar Germany fired up the printing presses to pay its World War I reparations, and when Aztec and Inca bullion flooded Habsburg Spain in the 16th century.
When central banks want to raise rates, they generally cannot do so by simple fiat; rather they sell government securities and remove the proceeds from the money supply. As the money supply decreases, so does the rate of inflation. When there is no central bank, or when central bankers are beholden to elected politicians, inflation will generally lower borrowing costs.
When levels of household debt are high, politicians find it electorally profitable to print money, stoking inflation and whisking away voters' obligations. If the government itself is heavily indebted, politicians have an even more obvious incentive to print money and use it to pay down debt. If inflation is the result, so be it once again, Weimar Germany is the most infamous example of this phenomenon.
Politicians' occasionally detrimental fondness for inflation has convinced several countries that fiscal and monetary policymaking should be carried out by independent central banks. While the Fed has a statutory mandate to seek maximum employment and steady prices, it does not need a congressional or presidential go-ahead to make its rate-setting decisions.
That does not mean the Fed has always had a totally free hand in policy-making, however. Former Minneapolis Fed President Narayana Kocherlakota wrote in that the Fed's independence is "a post development that rests largely on the restraint of the president. There is some evidence that inflation can push down unemployment.
Wages tend to be sticky , meaning that they change slowly in response to economic shifts. John Maynard Keynes theorized that the Great Depression resulted in part from wages' downward stickiness. Unemployment surged because workers resisted pay cuts and were fired instead the ultimate pay cut.
The same phenomenon may also work in reverse: wages' upward stickiness means that once inflation hits a certain rate, employers' real payroll costs fall, and they're able to hire more workers.
That hypothesis appears to explain the inverse correlation between unemployment and inflation —a relationship known as the Phillips curve —but a more common explanation puts the onus on unemployment. As unemployment falls, the theory goes, employers are forced to pay more for workers with the skills they need. As wages rise, so does consumers' spending power, leading the economy to heat up and spur inflation; this model is known as cost-push inflation.
Unless there is an attentive central bank on hand to push up interest rates, inflation discourages saving, since the purchasing power of deposits erodes over time.
That prospect gives consumers and businesses an incentive to spend or invest. At least in the short term, the boost to spending and investment leads to economic growth. By the same token, inflation's negative correlation with unemployment implies a tendency to put more people to work, spurring growth.
This effect is most conspicuous in its absence. In , central banks across the developed world found themselves vexingly unable to coax inflation or growth up to healthy levels. Cutting interest rates to zero and below did not seem to be working. Neither did the buying of trillions of dollars worth of bonds in a money-creation exercise known as quantitative easing. This conundrum recalled Keynes's liquidity trap , in which central banks' ability to spur growth by increasing the money supply liquidity is rendered ineffective by cash hoarding, itself the result of economic actors' risk aversion in the wake of a financial crisis.
Liquidity traps cause disinflation, if not deflation. In this environment, moderate inflation was seen as a desirable growth driver, and markets welcomed the increase in inflation expectations due to Donald Trump's election. In February , however, markets sold off steeply due to worries that inflation would lead to a rapid increase in interest rates.
Wistful talk about inflation's benefits is likely to sound strange to those who remember the economic woes of the s. When growth is slow, unemployment is high, and inflation is in the double digits, you have what a British Tory MP in dubbed "stagflation. Economists have struggled to explain stagflation. Early on, Keynesians did not accept that it could happen, since it appeared to defy the inverse correlation between unemployment and inflation described by the Phillips curve.
After reconciling themselves to the reality of the situation, they attributed the most acute phase to the supply shock caused by the oil embargo: as transportation costs spiked, the theory went, the economy ground to a halt.
In other words, it was a case of cost-push inflation. Evidence for this idea can be found in five consecutive quarters of productivity decline, ending with a healthy expansion in the fourth quarter of But the drop in productivity in the third quarter of occurred before Arab members of OPEC shut off the taps in October of that year. The kink in the timeline points to another, earlier contributor to the s' malaise, the so-called Nixon shock.
Following other countries' departures, the U. The greenback plunged against other currencies: for example, a dollar bought 3.
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