Before you get overwhelmed, know that inflation is very confusing for lots of people! You aren’t alone in trying to ignore it, but that won’t help your finances. Understanding inflation can help you make sure you’re taking the appropriate steps with your finances. Here is a brief introduction to inflation and how it affects your life.
Inflation, in its most basic form, is the idea that the government adds money into the economy and that adding money dilutes the value of the dollar.
This often causes prices to rise over time. Goods and services, like bread, for example, have the same value they always had but the money you are paying with is worth less than it used to be. It’s like pouring water into juice. At first, it looks like there is just more juice, but then you try it and the juice is lower quality. While inflation means there is more money circulating in the economy, each dollar is worth less than what a dollar used to be. Thus, it takes more dollars to buy the same goods.
Now, a quick history lesson. In the US, the government prints money. We used to have something called the gold standard, meaning that for every dollar printed there was a dollar worth of gold in the federal reserve. At this time, the American economy basically worked like a debit card. All of the money put into the market was money the government could back up with actual gold. This standard, however, was abandoned during the Great Depression.
Now, the country switched to fiat money, which just means that the money printed is only valuable because the government says it is. There isn’t any real commodity (like gold or silver) that your dollars represent. They’re now just paper, and it’s worth something because we all agree that it is. Crazy, I know, but stay with me.
This system of fiat money allows the government to balance the economy’s needs by controlling how much money is printed. Contrary to popular belief, inflation can actually be a good thing. The US aims to have an average annual inflation rate of 2.3% because it benefits the overall economy. In a recession, inflation is often increased to help us bounce back by increasing spending. When the economy is doing well, the inflation rate is decreased since it isn’t as needed.
Inflation can also be bad for consumers. Not only does it raise prices for normal goods, but it also affects your savings. Because money is worth less over time, so is your savings account.
Right now, check how much interest you earn on your savings accounts.
If the annual inflation rate is higher than that interest rate, you are actually “losing” money because your savings are being devalued faster than they are being increased. Because the US attempts to average at about 2.3% inflation, you want to find an account that averages 2.3% annual interest or higher to counteract this. This can also be done through investment returns or by investing your savings in things that don’t lose value like gold or government bonds.
Inflation also affects people in debt too, but we will discuss that in a future article. For now, feel free to reach out with any questions. Inflation can be a hard topic and our financial coaches are a great resource to help better understand this and help you make educated decisions. See our website for more information and who to contact.
Here to help,
Your Financially Fit Team