Key takeaways:
- Inflation can have positive and negative effects on the economy, businesses, and consumers.
- Moderate levels of inflation may result in higher employment rates, increased wages, and financial wins for borrowers and savers.
- Too much or too little inflation can have the opposite effect, causing economic slowdown, layoffs, and reduced consumer demand.
If you’re worried about inflation in 2022, you’re not alone. As of June 2022, the U.S. is facing the highest rates of inflation since the Great Inflation, a 17-year period stretching from 1965 to 1982.
Fortunately, inflation rates haven’t gotten close to 1980’s peak of 14.8%. Further, the Federal Reserve—the U.S.’ central bank—has since implemented monetary policies to help prevent extreme inflation through strategic interest rate hikes.
However, American consumers are feeling the pinch of inflation. But the effects of inflation aren’t all bad.
Let’s take a closer look at some of the benefits of inflation for consumers.
First things first: What is inflation?
For an in-depth look at inflation, its causes, and its impacts, check out our guide to inflation. In the meantime, you can think of inflation as an increase in the overall cost of goods and services.
Economists track inflation rates using two benchmarks: the Consumer Price Index (CPI) and the Personal Consumption Expenditures Index (PCE). As these benchmarks rise, costs go up while purchasing power decreases.
Pro tip: Purchasing power is the number of products or services you can buy with a single dollar. As inflation rises, the value of the dollar drops. As the value of the dollar decreases, your ability to buy products and services with it decreases, too.
Why is inflation necessary?
Essentially, healthy inflation rates indicate the economy isn’t heading toward a period of stagnation or deflation.
Pro tip: Deflation is the opposite of inflation and occurs when prices decrease and purchasing power increases.
Deflation may sound like a good thing—who doesn’t want to buy more products and services with less money? Unfortunately, deflation often occurs as a result of negative market activities, like:
- Lack of consumer demand
- Supply chain inefficiencies
- Decrease in credit availability or money supply
Can inflation be good?
Inflation can have some benefits for consumers, businesses, and the economy. Moderate inflation signals economic growth. Generally, a moderately higher inflation rate year-over-year means businesses are thriving and consumers are spending and borrowing money at an optimal rate.
What is a healthy inflation rate?
The Federal Reserve hasn’t set a specific target for inflation, but policymakers often aim for a 2% inflation rate.
Hitting the 2% inflation target is considered a sign of a healthy economy. Generally, moderate levels of inflation mean adequate access to money and credit. Similarly, it signals consumer demand is high.
What happens when inflation gets too high?
Too much unexpected inflation can have many of the same effects as deflation.
Unexpected spikes in inflation—also known as hyperinflation—can result in an economic slowdown and higher rates of unemployment. Costs may increase rapidly, resulting in lost purchasing power.
Consumers may then buy fewer goods and services, resulting in less demand for workers. Layoffs may follow, creating a phenomenon known as stagflation, where prices continue to rise alongside unemployment rates.
Why is inflation good? 4 inflation benefits for consumers
Curious how inflation can benefit consumers beyond preventing deflation? Let’s take a look at the 4 ways inflation can work to your advantage:
1. Inflation can increase employment rates
The relationship between inflation and employment is complicated at best. However, when inflation rises at a moderate level and is driven by consumer demand, it can lead to an increase in employment rates.
Higher demand usually results in slightly higher prices as producers work to provide consumers and businesses with more of the products and services they want. At the same time, the demand for workers grows, resulting in more jobs. Employed folks then go and spend more money, furthering the cycle and keeping the economy moving forward.
2. Inflation may result in salary bumps
Similarly, inflation may result in salary increases due to a higher demand for workers. When employment rates are high, there are fewer workers to choose from. Those who are available often demand higher wages, driving up average salaries across the board.
At the same, many businesses adjust salaries to better align with the cost of living. For instance, according to a survey by Salary.com, 73% of U.S. firms plan to increase payroll by 4% or more due to rising inflation and a tight labor market. Of those surveyed, 43% plan to increase their merit-based salary budget by 5% or more.
3. Inflation can boost Social Security benefits
If you or someone you know receives Social Security or Supplemental Security Income (SSI) benefits, inflation may lead to increased payments. The Social Security Administration (SSA) monitors inflation and may implement a cost-of-living adjustment (COLA) based on market conditions.
In January 2022, the SSA launched a 5.9% COLA. However, an SSA official revealed the COLA may increase to around 8% by the end of 2022, in light of current inflation rates.
4. Inflation can benefit borrowers and savers
Lastly, inflation can benefit borrowers and savers. Often, rising inflation leads to a slight uptick in interest rates. If you consistently put money into a savings account, certificate of deposit (CD), or money market account, you could earn more on your money thanks to high inflation rates.
Similarly, borrowers with existing debts can take advantage of inflation. Inflation reduces the value of the dollar. This means you can repay your debts with money worth less than it was when you took out a loan or used your credit card.
Why is inflation bad?
We’ve discussed a few reasons why inflation can be good for you and the economy. But when left unchecked, inflation can have some serious repercussions. Let’s look at several reasons why too much inflation is bad for consumers:
Inflation impacts those living on a tight or fixed budget
Inflation may result in salary bumps for workers. But if you or someone you know lives on a fixed income or a tight budget, inflation can make it harder to make ends meet. As the cost of living rises, your paychecks may not stretch to cover essentials, like groceries, healthcare, or transportation.
Inflation can lead to interest rate hikes
Remember the interest rate increases we mentioned earlier when discussing savers and borrowers? To combat inflation, the Fed may raise interest rates, especially if it begins to get too high.
Your savings account may benefit from the rate hike. But if you need to borrow money or make a purchase with a credit card, higher interest rates can increase the cost of your debt.
Inflation reduces purchasing power
Lastly, when inflation rises for months or years on end, it may erode consumer purchasing power.
As mentioned above, purchasing power tracks your ability to buy a certain amount of goods and services for one dollar. If purchasing power decreases, you can buy fewer goods for the same amount of money.
For example, consider a trip to the grocery store. Last year, you were able to buy 12 products for $50. However, as inflation rates increased and purchasing power dropped, the value of your money decreased as well. Now, you can only buy 9 products for $50, which means you either have to expand your grocery budget or shorten your grocery list.
Bottom line: Is inflation good or bad?
Inflation can be both good and bad. On the one hand, moderate inflation indicates the economy is growing. On the other hand, rising prices and eroding purchasing power can make it difficult to get by, especially if salaries don’t increase along with inflation rates.
This doesn’t mean you can’t do anything about inflation. You may not be able to change inflationary conditions across the country, but you can take steps to prepare financially for inflation.
No matter how you combat inflation, make sure you stay informed about your options and look for simple ways to improve your financial health. Inflation won’t last forever. But the steps you take to build a strong financial foundation will set you up for success for years to come.