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

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

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Inflation hurts your buying power. It means you have to pay more for the same goods and services. Inflation can help you if you are a lucky recipient of income inflation. You also might benefit from asset inflation, such as in housing or stocks, if you own an asset before the price rises. 

But if your income doesn’t keep up with inflation, your buying power declines. Over time, inflation increases your cost of living. If the inflation rate is high enough, it hurts the economy.

The effect depends on the type of inflation. For example, pernicious inflation is between 3-10 percent a year. It heats up economic growth too fast. People buy more than they need to avoid tomorrow's higher prices. Suppliers can't keep up. More important, neither can wages. As a result, everyday goods and services are priced out of the reach of most people.

Asset Inflation

Inflation doesn't affect everything the same way. For example, gas prices could 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 percent. Meanwhile, inflation occurred in oil prices. They 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. That was at a time when many workers were worried about keeping their job.


The federal government enacted the economic stimulus plan to end the recession. Then the Federal Reserve started quantitative easing. Investors grew worried about inflation. As a result, they bought gold. The price of gold rose 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. Overall,  inflation is better than deflation for the economy.

When Inflation Is Good for the Economy

Sometimes inflation is good for the economy. When it's mild, inflation has a healthy side effect. Once people start to expect inflation, they will spend now rather than later. That's because they know prices will be higher in the future. Consumer spending drives economic growth. 

In fact, the Federal Reserve sets an inflation target. It wants a healthy inflation rate of 2 percent. That applies to the core inflation rate. It takes out the effect of food and energy prices. The central bank does this to make you believe prices will continue rising. It spurs the economy by making you buy things now before they cost more. 

Effect on Retirement Planning

Inflation is terrible for your retirement planning. Your target must keep rising to pay for the same quality of life. In other words, your savings will buy less as time goes on. As a result, to be prepared for inflation during your retirement, you should save more than you think you will need.

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.

Impact on Treasury Bonds

You must monitor inflation if you hold 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. 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. As a result, most mortgage interest rates increase.

Higher rates lower the value of your investments. They also increase the cost to the federal government of financing the U.S. debt. The interest on the national debt rises. The additional budget expense needs to be offset by a cut in the discretionary budget or an increase in taxes. Otherwise further deficit spending will occur. All of those are contractionary fiscal policies that slow economic growth. That translates into a lower standard of living for you. 

When Inflation Is Catastrophic

If inflation reaches the double-digits, that's hyperinflation. If it happens, you will need a wheelbarrow of money to buy a loaf of bread. Hyperinflation only occurs when the government is so irresponsible that it prints money without regard to the inflation rate. It happened in Germany in the 1920s and 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. Hyperinflation could lead to a U.S. economic collapse.

Fortunately, the Federal Reserve chairs are the major players in the fight against inflation. The Fed has many tools to stop inflation in its tracks. The Fed can raise interest rates by increasing the fed funds rate. That makes borrowing more expensive, so people are less likely to buy cars, appliances, and homes. The Fed is very serious about controlling inflation. As a result, it is unlikely that you will need to protect yourself from inflation.