How Does Inflation Impact My Life? Impact on You and the Economy

Why President Reagan Said "It's as Violent as a Mugger"

U.S. Treasury Re-Designs Dollar Notes
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Inflation hurts your buying power. That's because rising prices mean you have to pay more for the same goods and services. Inflation can help you if you are the lucky recipient of income inflation. You can also benefit from asset inflation, such as in housing or stocks, if you own that asset before the price rises. However, if your income increases at a slower rate than general inflation, your buying power declines even if you are making more.

Many people get hurt by an asset bubble if they try to time it, and buy right when the bubble is about to burst. Overall, inflation reduces your standard of living.

Inflation doesn't affect everything equally. Gas prices can double while your home loses value. That's what happened during the financial crisis of 2008. There was deflation in home prices, which fell 31.8%. Meanwhile, inflation occurred in oil prices, which reached an all-time high of $148 a barrel. Since oil prices drive gas prices, the cost of gas rose to $5 a gallon. Driving to work became even more expensive, and stressful, at a time when many workers were worried about even keeping their job. For more, see Inflation and Deflation: Causes and Effects.

Once the Federal Reserve started Quantitative Easing and the Federal government enacted the economic stimulus plan to end the recession, investors grew worried about inflation.

As a result, they bought gold. It drove the price of gold to a record of $1,895 an ounce on September 5, 2011. In this instance, there was inflation in gold and oil prices, with deflation in housing prices and personal income.

Inflation has another side-effect. Once people start to expect inflation, they will spend now rather than later.

That's because they know prices will be higher later. Consumer spending heats up the economy, creating ever-higher inflation. It's called spiraling inflation because it spirals out of control.

If inflation reaches the double-digits, that's hyperinflation. If it happens, you will need a wheelbarrow to buy a loaf of bread. It only happens when the government is so irresponsible that it prints money without regard to the inflation rate. It happened in Germany in the 1920s, and in Zimbabwe in the 2000s. If inflation ever approaches the double-digits, your best defense is to buy gold or any currency that isn't pegged to the dollar. For more, see U.S Economic Collapse.

Effect of Inflation on Retirement Planning

The combination of inflation in some asset classes, and deflation in others, makes financial planning more difficult. Rules of thumb no longer apply. One of the reasons government economists didn't do more to head off the recession was because they couldn't believe housing prices would ever fall.

Inflation is really bad for your retirement planning because your target has to keep getting higher and higher to pay for the same quality of life. In other words, your savings will buy less.

As a result, you will need to save more today to pay for higher-priced goods and services in the future. 

Impact of Inflation on Treasury Bonds

Inflation is important if you are holding bonds or Treasury notes. These fixed income assets pay the same amount each year. As inflation rises faster than the return on these assets, they become less valuable. That's when people rush to sell them, further depreciating their value.  When that happens, the U.S. government is forced to offer higher Treasury yields to sell them at all. This increases most mortgage interest rates.

This lowers the value of your investments. It also increases the cost to the Federal government of financing the U.S. debt by raising the interest payments each year. The additional budget expense needs to be offset by a cut in the discretionary budget, an increase in taxes, or further deficit spending.

All of those are contractionary fiscal policies, and will slow economic growth. That translates into a lower standard of living for you. 

Inflation FAQ