28 Oct Shades of 1977–What the Heck Is Inflation?

Here’s what you need to know

By Sheryl Nance-Nash

There hasn’t been this much buzz about inflation since the 1980s. When the Bureau of Labor Statistics reported in June that inflation was 9.1 percent, that was its highest level since the 12-month period ending December 1981, when it was 8.9 percent, as measured by the Consumer Price Index.

Inflation is a general increase in the prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation results in the reduction of money’s purchasing power. But you probably don’t need a definition. You’re likely experiencing inflation firsthand­—at the gas pump, at the grocery store, while paying your rent, and elsewhere.

Inflation’s impact on a household can be mild—more of an annoyance about having to pay more than you’re used to paying—to severe, if suddenly you’re struggling to make ends meet.

A widespread increase in prices “can be the result of very strong demand for products and services, so much so that it pulls prices higher. A good example is when everyone wants a certain toy for the holidays, it sells out in stores, and private sellers pop up asking ridiculously high amounts for their stash,” says Kelley Holland, author of You Are Worthy: Change Your Money Mindset, Build Your Wealth & Fund Your Future. “Inflation can also stem from an increase in the cost of producing things, which then leads manufacturers to push up prices.”

Inflation is here, and who knows how long it will hang around and put a drag on the economy. You need a plan to move through inflationary times. Here’s what to keep in mind.

What’s causing inflation?

“A certain level of inflation is healthy and necessary to support a vibrant, thriving, and resilient economy. That level is 2 to 3 percent annually,” says Mike Davis, founding partner of Olive Tree Ridge, an asset management firm and investment bank.

But when the level gets above that, it can shake up the economy. Inflation can be caused by a variety of factors including an increase in the money supply, a decrease in the supply of goods and services, or an increase in demand, for example. This past year, the supply-chain bottlenecks have wreaked havoc with prices, and demand has been fueled by all those online shoppers in particular.

“Most experts point to the various government stimulus measures enacted after the onset of the COVID pandemic as the main driver of the current inflationary environment,” says Houston Friend, a financial planner with Redeem Wealth.

Impact of inflation?

Tom Kelly, a former financial advisor and current chief technology officer at Life Part 2, a company that helps people plan for retirement, talks about the ramifications of inflation. “Firstly, it can lead to a decrease in the value of money, which can have a negative impact on people’s standard of living,” he says. “Secondly, it can lead to higher interest rates, as lenders need to protect themselves from the potential losses that can come from inflation. This can make it more difficult for people to borrow money and can increase the cost of borrowing. Finally, inflation can also lead to higher prices for goods and services, which can cause people to experience a decrease in their standard of living.”

Higher interest rates typically slow the economy. Inflation can create uncertainty and instability in the economy. To help visualize the impact of inflation, consider that according to fintech company Self, with $1 you could buy 125 lemons in the 1910s (the largest number you could get for your dollar in the 20th century). Since 2010, $1 won’t buy even two lemons.

What’s worrisome is that wages often don’t keep up, normally lagging inflation by several months. “This is being proven out now as real wages have declined for several months in a row,” says Doug Carey, a chartered financial analyst and president of WealthTrace, a retirement and financial-planning software company. “If wages are declining relative to overall prices, this is the same as one’s pay being cut. When wages are keeping up with inflation, the increase in prices is not as much of a concern. However, sustained inflation usually leads to economic growth stalling and even recession. This is something all of us need to be concerned about.”

Imagine your wages lagging inflation by 3 percent for five years in a row. After five years, your paycheck’s purchasing power will have been cut by 16 percent. “For most people this means a halt to all savings, as well as cutting back on spending,” Carey says.

Smart strategies for managing inflation

As much as inflation can be a burden, that’s not to say there are no weapons to tame the beast. One of the first things you want to do is eliminate any debts you have or increase payments on them, especially those with variable interest rates, as there will be an uptick in your payments, says Keisha Blair, economist and author of Holistic Wealth (Expanded and Updated): 36 Life Lessons to Help You Recover from Disruption, Find Your Life Purpose, and Achieve Financial Freedom. Tighten spending. Live within your means and think necessity vs. wants. Think twice about any big purchases, particularly if you borrow in order to purchase. That debt will be pricey. “Spend less, and put that money toward savings. Start or strengthen your emergency savings,” says Blair.

For sure, a major pain point is the hike in prices at the grocery store. Blair suggests doing a meal plan, creating a list before going to the store, and sticking to it. Because you can only cut so much, look for opportunities to earn extra income, be it a side hustle or putting in overtime at work, she says. Also, given that it is a buyers’ market for jobs, you might consider asking for a raise—or seeking a new job elsewhere.

Keep your eyes and mind open. Just because inflation is around doesn’t mean you should hide your wallet. A great investment right now, says Carey, is Treasury Inflation Protected Bonds (TIPS). The interest rate on these bonds has the annual inflation rate added to them. Because of this, investors can now get over 9 percent interest on TIPS bonds. “Relative to bank accounts, which still barely pay above 0 percent, this is a great place to invest,” he says.

Steve Wilson, founder of personal finance site Bankdash.com, points to real estate investment trusts (REITs), companies that hold and manage properties with an income stream, as a good investment during inflationary times. “Home values and rental revenue tend to increase along with inflation. A group of properties make up a REIT, which distributes dividends to its investors,” he says.

As for stocks, consider including in your portfolio those that are linked to commodities, which tend to keep up with inflation.

Joel Ho, founder of Inflationtraining.com, says most people’s bills revolve around energy, food, mortgages, taxes, and miscellaneous purchases. “Energy you can cut using more efficiency—such as better insulation depending on location—and reducing usage,” Ho says. “Food can’t be cut, so the trick is to be as self-sufficient as possible—start a garden now. Mortgages—do not get an ARM (adjustable rate mortgage) during inflation! Stay with the fixed rate mortgage; you pay more up front, but your payments can’t grow. Finally, inflation pushes up real estate, so your tax assessments are likely to go up—remember to challenge them if you are paying above market prices.”

Stop complaining about how expensive gas is and do something about it. “Carpool and plan your shopping and other driving, so you reduce your gas consumption,” says Sathya Chey, a managing partner with Arise Private Wealth. Walking more and using public transportation even a little bit can make a difference.

Who knows how long inflation will dominate the headlines. Says Chey, “Don’t stick your head in the sand. With the rapid increase in inflation currently, there have been material changes in the cost of your living expenses­—so rapid that you may not have had time to adjust. Don’t get yourself in debt or spend your emergency reserves down to try and sustain your pre-inflation lifestyle.”

Lastly, she adds, “Now is the time to get smart and focus on what things in your life bring you the most value and happiness, and cut the extras that add only incrementally to your comfort and happiness. Small changes in spending could compound to a substantial amount of savings as you wait for the economy and inflation to level out.” DW

Sheryl Nance-Nash is a freelance writer specializing in personal finance, small business, and travel topics. Her work has appeared in the New York Times, the Wall Street Journal, Newsday, Global Traveler, and Afar, among others.

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“Spend less, and put that money toward savings. Start or strengthen your emergency savings.”