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This is How Inflation Hurts the Economy

how does inflation hurt the economy

by Robert

n 1924 a bottle Coca-Cola cost five cents, today it’s $1.50 if you’re lucky. I paid $2.50 at an airport vending machine the other day, and wasn’t happy about it. In 1921 a Hershey Chocolate Bar also cost a nickel, today it can be as much as ninety-five cents in a convenience store.

Coca Cola probably doesn’t taste thirty times better than it did in 1924, or brings that much more value to a customer. Instead, our money is simply worth less per unit. That means that as you make money, you’re fighting an uphill battle. Owning assets that accrue value (such as property or commodities like gold) offset that loss in a financial portfolio.

We all know that things cost more over time, and because those of us in economics like to overcomplicate things we call this pesky little tendency “inflation.”

In fact, over the last 60 years, prices have risen by an average of 5% per year. It ebbs and flows with the economic climate, obviously. The Carter stagflation of the late 1970’s sent inflation rates soaring into double digits, while the technological bubble of the 1990’s often kept it below 2%. It hasn’t always been that way, lots of the 1800’s saw “deflation,” where the price of goods and services actually dropped over time. It was every bit as unpopular as today’s macroeconomic trend.

It’s popular to say that inflation hurts the “purchasing power” of consumers, because you can get less bang for your individual buck. That’s not accurate, strictly speaking, because as prices go up, wages also increase at a similar rate.

What it does mean, however, is that your savings are worth less. If you have ten thousand dollars sitting in

a checking account that doesn’t pay interest, after a year of 5% inflation, you’ve essentially lost $500. If that trend continues over ten years, it can be devastating to your nest egg and personal financial planning. Investing in gold is one way to hedge against that risk. The government can’t print more gold, and it’s

The loss of savings value is sometimes called an “inflation tax,” because the government often finances its deficit by printing more money, which causes inflation. This phenomenon is explained in other articles like “Why Printing Money Causes Inflation.” It’s not a traditional tax because you don’t mail any checks or file paperwork with your accountant. Your savings are simply worth less in market value, and that printed money finances the government.

The good news is that as inflation climbs, interest rates also usually trend upward, meaning the interest you earn on savings makes up for some of the loss. It still takes a chunk of your portfolio, and should be factored into any long-term financial plans. Long-term saving for a significant purchase can be derailed by a lack of planning.

Another strain on the market is what economists call “menu cost.” Prices don’t slowly creep upward, they jump by increments that average about once a year. Businesses have to pay overhead and administrative cost to revamp payrolls and prices accordingly, hence the name alluding to rewriting restaurant menus.

Inflation is inevitable in the foreseeable future. It’s slowed down during the recession, but the Obama administration’s massive deficit spending and injection of currency into the monetary base ensures that it will climb again. That costs money. Protect against inflation: make sure your savings are yielding interest in excess of inflation rates, and invest in gold.

Category: Bank

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