Understanding the Impact of Inflation

There have been rumblings in the news about inflation, and whether the jump in gas prices (combined with an economy on the rebound) warrants the Feds raising interest rates. Despite these factors, the Fed does not anticipate raising federal interest rates.

So is there reason to be concerned? Let’s unpack inflation.

What is Inflation?

The definition of inflation, put simply, is the decreasing purchasing power of currency over time. While things feel more expensive, one of the causes of inflation is too many dollars in circulation. So rather than prices increasing arbitrarily, the value of money is decreasing.

Consider foreign exchange rates—when you convert your money to a new currency, it’s not a 1:1 ratio. Some currencies are stronger, and some are weaker. These fluctuating values are a result of inflation across the globe—they all interact.

Understanding the CPI

The CPI (Consumer Price Index) is one of the most commonly used measurements of inflation. Using a “basket of goods,” the CPI measures price changes in these goods over time. Such goods include typical groceries like cereal, bread and milk, as well as things like gas, funeral services, and furniture. 

While some years have massive inflation, other years have low or even negative inflation (deflation). However, the history of the CPI shows us that the average inflation is about 3%.

How to Adjust for Inflation

While inflation resources are handy, it’s important that we understand how to read inflation prices. Otherwise, we get caught up in a scarcity mindset—because we see that gas has increased over the years, without considering the actual value of the money we are using.

On an intellectual level, everyone understands that inflation affects prices. We expect prices to rise in the future—the price of a product or service costs more because our money is worth less. At the same time, technology and other economic factors can also affect prices, which is why computers and other electronic technology devices seem to get cheaper, even with monetary inflation. So it can be hard to tell if the things we buy are really more expensive than they used to be.

Therefore, economists have developed the idea of adjusting for inflation. By taking the price for a similar commodity from the past and adjusting that number for inflation, it provides a method for comparing prices from different eras. 

To become a true steward of your personal finances, you should learn to adjust for inflation so you know the true value of your money. This can also help you learn to speak the “language” of financial advisors and know whether they are providing sound financial advice based on accurate and adjusted calculations.

Question: According to the GasBuddy website, the average price for a gallon of gasoline in the United States on October 21, 2020, was $2.15.

Adjusting for inflation, how does this price compare to the average price in 1980?

A.)  Higher

B.)   Lower

C.)   About the same

And The Answer Is…

The correct answer is “B”.

Using data from the Consumer Price Index, which the Bureau of Labor Statistics uses to calculate inflation, $2.15 today is the equivalent of $0.69 in 1980. From historical information provided by the Energy Information Administration, the average price of a gallon of gasoline in the United States in 1980 was $1.19 per gallon. This means a gallon of gas is about 42% cheaper today than it was 40 years ago.

Outsmarting Inflation

Overall, inflation is going to have an impact on your cash—especially if you’re not growing and protecting it. However, it’s important to make decisions with a mind for Prosperity, NOT scarcity. Some things, like your mortgage payment, will actually feel cheaper over time. On the other hand, your utilities probably won’t.

Wrapping your mind around inflation and what it will and won’t do to your money is the first step. If you’d like help inflation-proofing your money where it counts (and taking advantage of inflation where you can), let us help you. Contact us or email welcome@prosperitythinkers.com to get started today!