Financial Tips

What is Inflation?

Inflation is a rise in prices, or a decrease in the purchasing power of money. While sometimes individual item prices may climb due to shortages or increased demand, inflation is generally measured across a wide range of goods and services. The increase—or decrease—in prices across this range is expressed as a percentage point.
  • For example, since 1960, inflation has increased an average of 3.79% a year. That means that prices today are about 10 times higher than back then. What $1 would buy in 1960, now takes $10.

Inflation by itself isn’t necessarily a bad thing. If you own property or commodities, some level of inflation means that your goods are increasing in value. If you have a fixed rate loan, inflation means that you’re paying the same amount of money each month but getting a higher value for it. It can also stimulate the economy by encouraging higher rates of spending, both in investments, as people seek higher gains than those yielded by inflation, and in general spending, as fears of greater inflation lead consumers to buy now rather than later.

On the downside, consumers have to pay more for goods and services, and any money that is not invested in a high-yield savings vehicle is essentially losing value over time. Wages may not keep pace with inflation, leading to even further decreases in purchasing power. If not kept under control, inflation can skyrocket to the point where money essentially becomes worthless.

The Federal Reserve (or “the Fed”) is tasked with controlling inflation. Typically, they do this by adjusting interest rates. If inflation is low, they lower interest rates to try to boost spending. If inflation is high, they raise interest rates to try to slow the economy. Raising it too high, too fast, however, can cause a recession.

Generally, the Fed tries to keep inflation to an average of 2%. This is just high enough to keep the economy growing and prices stable.

If you’d like to learn more about the Federal Reserve and how it works, check out their website.

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