Figure Out How Inflation Works

Join the Money Funnies as they discuss the general rise in the costs of
goods and services over time.

Inflation is a general rise in the costs of goods and services. Not just that, say, the price of wine went up, but that wine, furniture, electricity and hair cuts did. In other words, all the prices go up so the real value of money you make goes down.  

Real value of money is how much it can be used to purchase.
Nominal value is a set amount or price, not adjusted for inflation.

This happens almost constantly. There have been periods of deflation in history, when prices go down across the board, but they are rare and usually short. It happened in 2009 at the beginning of the recession, but ended in less than a year. 

Inflation = the constant rise in the general level of prices so one dollar buys less than it did before
Deflation = the reduction of the general level of prices

There have been periods with high rates of inflation in history, where prices went up really quickly. Recently, hyperinflation happened in Venezuela, where prices rose several hundred percent several years in a row.  

Hyperinflation happens when prices rise 50% or more in a month. It is very rare.

Doesn’t this mean our money is worth more now than later?

Over time money devalues. That’s part of why earning interest on your savings and buying things that last is so important. 

However, inflation in the US hasn’t been over 6% in the last 25 years and has been under 3% the last five years. It’s been at a pretty steady rate since the beginning of the last recession in 2009. 

But prices keep rising almost all the time. Most things cost about 2.5% more than they did a year ago. Ideally your wages go up a similar amount. (Though I recognize this is unlikely in 2020. I, like many people, make less money now than a year ago.)

Why does inflation happen? 

There are several reasons, though experts continue to discuss why it happens. The prices of some things go up because of scarcity or some issue, say in the supply chain, and it ripples into other items. Overall, scarcity, real or imagined, is a big driver of inflation. 

When there’s a lot of inflation, it may have been caused by excessive growth in the money supply, like the government literally printing too much cash or the discovery of new and large amounts of heavy metals like gold.

What can we do to protect ourselves? 

Protect yourself against inflation by putting money into interest-bearing accounts, creating good habits that lessen future spending, and by asking for cost-of-living raises.

Interest creating accounts are your easiest bet. 

If you can, buying a house can be a hedge against inflation, but that comes with its own challenges. 

Create good habits that lessen future spending, like taking care of your teeth to cut back on dental costs. Like so much we discuss, it’s about creating good habits. 

And negotiate everything, especially your salary but also big items like rent. 

To see the change in the value of money over a specific period, try this inflation calculator from the Federal Reserve Bank of Minneapolis.

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