Understanding Inflation

Understanding Inflation

Have you noticed higher prices at the gas station and grocery store? That’s inflation at work.

Inflation reflects the rising prices of goods and services. Rising prices decrease your purchasing power, meaning your money won’t go quite as far as it did before.

The Consumer Price Index, a measure of the average price of goods at a specific time, helps economists measure and track inflation. With this index, they can compare the changes in cost averages to determine the rate at which they’ve increased.

The good, the bad and the ugly

Inflation affects both individuals and the wider economy in different ways – not all of which are bad.

For instance, with rising inflation, consumers might be more willing to spend money now as opposed to waiting to do so when prices rise even further. As a result, demand can increase, and companies can increase production to meet it – often resulting in more hiring and a boost in economic growth.

Plus, inflation decreases the likelihood of deflation – or decreasing prices for goods and services. While cheaper prices might sound good, when applied over time at scale, deflation can lead to layoffs and slow the circulation of money within the economy.

Of course, inflation can be painful at the individual level. Unless wages increase to match the rate of inflation, people may be forced to spend less or be unable to afford essentials like housing, childcare or groceries.

Inflation can also create more inflation. With less money circulating, businesses may raise prices to offset fewer customers. Businesses too may be pushed toward making sacrifices, including laying off employees.

What causes inflation?

When prices increase, it’s typically in the result of supply and demand. Specifically, prices increase in one of two ways: demand-pull and cost-push.

Demand-pull inflation is when prices increase due to unusually high demand. For instance, during the early months of the COVID-19 pandemic, demand for disinfectants and hand sanitizer spiked, resulting in shortages and increased prices for those goods.

On the other hand, cost-push inflation occurs when the supply of goods that consumers want is unusually low. Oil and gas prices are a common example of cost-push inflation. For example, natural disasters or conflict in parts of the world that supply oil can affect its distribution. Demand for the product remains high, but prices go up because it’s harder to get to consumers.

The takeaway

Inflation is a normal part of a healthy economy – but too much can push down your purchasing power and create problems throughout the economy. If you’re struggling to get a hold of your budget in this environment, stop by a UW Credit Union branch for a free credit consultation.