How Does Inflation Affect Me?

“Inflation” – you’ve probably heard the word many times in your life and perhaps thought to yourself, but how does inflation affect me?

You may have learned about it at school, picked up on the concept on TV news and the radio, and of course most recently been surrounded by the talk of it, though you still don’t know what its impact could be for you.

Yes, it sounds boring, but it has more implications on your life than you may think. Let’s find out how inflation could affect you.

Understanding Inflation

Think of inflation as to how far your money will get you today compared to how far that same amount of money will get you in the future.

You’ve probably noticed that some food items’ prices have gone up in your lifetime, or that it’s more expensive to buy gas, or go to the movies. That is inflation.

Why does inflation happen? It could be for different reasons.

• Inflation can happen when more people want a certain product. For example, if 100 new people move into your neighborhood and buy homes, the average sale price of property will skyrocket because there will be less of it available.
  
  
  That is what Demand-Pull Inflation is, and it is a concept that is reliant on the principle of supply and demand. It’s the same thing for common items such as flowers for example – most people buy their partners roses on Valentine’s Day, so florists bump their prices up because they have fewer items available.
  
  

• Inflation can also happen when the price of the things that are needed to manufacture certain products goes up, such as raw materials. If a company has to buy something for more money than usual because there is less of it available, it will have to raise the price of the finished product. This is called Cost-Push Inflation, otherwise known as “supply shock inflation.”
  
  

How Does Inflation Hurt the Economy?

When prices rise, the economy as a whole is affected. If it is more expensive to purchase energy, food, clothes, gas, and many more necessities, it has an immediate effect on economical systems.

Inflation changes how much it costs to rent a place to live, to buy property, to run a business; how easy it is to get a loan, and even how efficiently governments can function. 

Let’s talk about some of the main effects of inflation on the economy:

Inflation Deteriorates Purchasing Power

As inflation is a rise in prices, it inevitably decreases the purchasing power within a currency. For example, in the U.S, the price of a cup of coffee a few decades ago used to be a dime, and it is now three dollars on average.

Inflation Makes People Spend Irrationally

When people are faced with something they are used to buying suddenly becoming more expensive, their first response is to buy it “while they can.”

You may be familiar with the toilet paper anecdote that occurred during COVID. In a situation of crisis, shoppers bought huge amounts of necessities.

Situations like this create inflation, and it makes cash lose some of its value. Consumers fill up their freezers and pantries, buy clothes and shoes in the next sizes up for their kids, fill up their gas tanks, and more.

Unfortunately, this type of pattern is counter-productive, because it is driving up the prices even higher and creating demand-pull inflation, which we discussed earlier.

Inflation Causes a Feedback Loop

The urge to spend that inflation brings about often causes a nightmarish feedback loop whereby prices go up, people spend, which makes prices go up even more, so the value of a currency is worth even less, and so on.

This can result in hyperinflation, which you may have heard happened to Weimar Germany in the 1920s. Their German mark (the name of the currency at the time) was so worthless because of hyperinflation that some Germans were using it as wallpaper.

In Zimbabwe in the 1980s, Zim dollar notes were hauled in wheelbarrow loads to afford the most basic of commodities such as food.

Hyperinflation is extremely high and fast-increasing inflation.

What is Inflation Risk (aka Purchasing Power Risk)?

Because inflation affects the whole economy and the value of a currency so deeply, there is a great worry to be felt regarding the status of future investment value. Let’s understand why.

Inflation is a drop in the value of money over time. If governments and financial institutions don’t succeed in reacting to inflation, the effect could be so important that the value of any property or asset will decrease durably.

For example, let’s say you get a good job that allows you to purchase a home. For now, you rent it out, and you can pay back your mortgage every month.

This sounds like a great investment and a rather foolproof plan. You aim to be able to retire with the income you generate from this purchase, or whatever profit you make once you’ve paid back your mortgage.

However, unfortunately, a pattern of increased inflation hits in a few years. What used to be a $25,000 total value of that investment is now only $23,000 because the value of the currency has decreased.

If inflation progresses, it may even get worse in the future, and go down to $20,000. This means that what you would have been able to buy with $25,000 you can no longer buy anymore because your money has a spending power of $20,000.

That is what inflation risk is – the anticipation that investments won’t be worth as much as they were worth when purchased.

In 2020, the inflation rate in Canada averaged at approximately 0.72 percent compared to the previous year. In the US, the rate of inflation in 2020 was 1.4% in 2020. This means that the USD is worth 1.4% less than the previous year.

How Can Inflation Affect Me?

To put it simply, if your wages won’t be going up at the same speed as the inflation rate, you’ll most likely be affected by inflation. Seen as how younger people are more likely to be in entry-level positions (lower paid), the chance of inflation affecting your spending power is higher.

Younger people are also much more likely to rent than to own, so that could also affect you in the near future. When inflation occurs, rent gets higher. The price of education also increases.

As you may have noticed by now, inflation is a real issue that governments have to face head-on every day. The recent pandemic has made inflation issues worse all over the world.

So how does inflation affect me? In the next few years, people will have to face new economic challenges, especially the youngest generation, who will need to learn how to deal with the changes to come. Learning the effects of inflation on your cost of living will allow you to prepare for your future.

By: Robert Puharich | September 13, 2021 |