How Does Inflation Affect Bank Accounts?

Shrinking Dollar
Inflation shrinks the purchasing power of a dollar. JOE CICAK/E+/Getty Images

Have you ever heard discussions about how cheap it was to buy gas (or milk, or houses) in the “good old days”? Prices tend to rise over time due to inflation, but inflation can be hard to make sense of. So what will inflation do to your bank accounts, especially if it heats up in the years to come?

Inflation makes money less valuable. The result is that one dollar buys less than it used to every year (so goods and services appear more expensive if you just look at the price quoted in dollars).

During periods of high inflation, you might assume that things will be more expensive next year than they are today – so there’s an incentive to spend your money instead of saving it.

But you still need to save money and keep cash on hand, even though inflation threatens to erode the value of your cash. You’ll obviously need your monthly spending money in cash, and it’s also a good idea to keep emergency funds in a safe place like a bank or credit union.

Interest Rates

The good news is that interest rates might rise during periods of inflation. Your bank might not pay much today, but you can expect your annual percentage yield (APY) on savings accounts and certificates of deposit (CDs) to get more attractive.

Savings account and money market account rates should move up fairly quickly as rates rise. Short-term CDs (6-12 months, for example) might also adjust. However, long-term CD rates probably won’t budge until it’s clear that inflation has arrived and that rates will remain high for a while.

In an ideal world, savings rates would keep up with inflation so you’d break even. In reality, rates lag behind inflation, and income tax on the interest you earn means you’re probably losing purchasing power at the bank.

What to do With Bank Accounts

What does this mean for your saving strategy? If you think rates will rise soon (or quickly), you might wait to put cash into long-term CDs, or use a laddering strategy to avoid locking-in at low rates.

It’s also a good time to keep an eye out for better deals. Some banks will react to higher interest rates more quickly than others. If your bank is slow, it might be worth opening an account elsewhere (online banks are always a good option for good savings rates). But remember that the difference (or your account balance) really needs to be significant for you to come out ahead: switching banks takes time and effort, and you money might not earn any interest while moving between banks. Plus, the bank with the best rate changes constantly – the important thing is that you’re getting a competitive rate.

Finally, do some planning to make sure you have the right amounts in the right types of accounts. Bank accounts are best for money that you will or might need in the near-to-medium term. If you lose a bit of purchasing power due to inflation, that’s the price you pay for having an emergency fund – and it might be well worth that price. Talk with a financial planner to find out what, if anything, you might do with longer-term money.

Borrowing Money?

If you’re concerned about inflation, you might get some consolation from knowing that long-term loans could actually get more affordable. If a few hundred dollars feels like a lot of money today, it won’t feel like quite as much in 20 years (assuming your income rises with inflation – and your monthly payments stay the same).

Assuming you don’t intend to pay your loans off early, student loans that get paid off over 25 years and 30-year fixed-rate mortgages might be a little easier to handle.

All that said, reducing debt is always wise, and you’ll still pay interest over all those years.

Unfortunately, short-term loans with variable rates will get more expensive. To see how your payments change as interest rates change, run some loan calculations.