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The Misunderstood Side of Inflation

It is no surprise the cost of everything keeps raising. I remember when a candy bar cost $0.49. It is easy to see the cost of items we buy rise, but are you aware of why the cost of goods rises and how it is not only a bad thing, but is something necessary for our economy? Here are five common questions you might have to help you better understand inflation and how it effects you.

What is Inflation?

Investopedia defines inflation as, “a sustained increase in the general level of prices for goods or services.” Inflation is measured by the percentage amount increase each year. Essentially, as inflation increase each year, the amount you can purchase with your dollar decreases.

For example, US News reported buying a home in 1915 would have cost you around $3,200. A loaf of bread was $0.07; a dozen eggs cost $0.34 and a movie ticket for a child was $0.10 to $0.15. With that being said, the yearly take home pay in 1915 was around $687. So how does inflation affect you and the money you earn?

Are Rising Prices a Bad Sign?

When people think about inflation, their first reaction is things cost more due to inflation and it isn’t a good thing. But, inflation isn’t all bad. It depends on if the inflation is expected or not. When inflation is expected, wages generally increase to keep up with the inflation increase. Banks can also keep up with inflation increases by adjusting interest rates to balance out the change in inflation.

Are There Different Forms of Inflation?

A problem with inflation comes when the increase or even decrease is unexpected. When a decrease in inflation is unexpected, called deflation, this can be a sign of a weakening economy. Rarely, inflation happens very quickly, called hyperinflation. This can be a sign of the breakdown of a countries currency. If inflation increases unexpectedly, society can be affected in different ways. Retirees living on a fixed amount of income can suddenly have less money to meet their needs, creditors lose out on interest, consumers are less likely to spend, and products become less competitive compared to other countries. Generally, inflation increase 2-3% each year in the United States and other developed countries.

How Does Inflation Relate to Interest Rates?

Inflation and interest rates are usually discussed in the same sentence, but how do these relate to each other and how does that affect you?

The Federal Reserve is the group who make the decisions about interest rates. They meet at various times throughout the year to analyze the economy and make adjustments as needed. The Federal Reserve looks at how the economy is performing and how that is effecting inflation to decide the interest rates to keep the economy as stable as they can.

For example, if the economy is growing too quickly, to avoid hyperinflation, the Federal Reserve might increase interest rates to slow consumer spending. If the economy is in a financial crisis, the Federal Reserve might ease up interest rates to avoid a market meltdown and to help individuals get out from under high interest investments. Ultimately, the interest rates are decided to keep inflation under control and keep the economy running as smoothly as possible.

What Should You Remember About Inflation?

We seem to see the cost of items rising and automatically assume it is a bad thing. But, you must remember that most likely if the cost of items is rising, so are your wages. The minimum wage in 1950 was $0.75. Today, it is between $7-$9 based on the state you live in. Those changes of wages are due in part to inflation. Sure, things cost a whole lot less 65 years ago, but incomes were considerably lower as well. Inflation is a necessary part of a stable economy. Next time you complain about the rising cost of goods and services, remember the raise equals out with wages and is keeping the economy stable.