Sometimes, you just want to sit around and ask the big questions: What’s the meaning of life? Does a tree make a sound if it falls in the forest and no one’s around to hear it? And what causes inflation? Let’s tackle that last one.
Inflation has gone nuts lately and impacted all our lives, but most people don’t even know where it comes from or what drives inflation. They just know inflation is the bad guy and they hate it. Even though we can’t change the inflation rate, we can learn more about what’s causing inflation and how to tweak our money habits to combat it. So step into our time machine as we go back to that part of Economics 101 you snoozed through.
What Causes Inflation?
A lot of behind-the-scenes stuff can kick-start inflation. And most of the time, it’s a combination of those things that ignites the fire and gets inflation to start heating up. Here are a few of the common causes of inflation:
If you really want to know what causes inflation, a big part of it goes back to demand-pull inflation. This happens when the demand for goods goes up but the supply stays the same. If sellers can’t keep up with the demand, then they can raise their prices. This makes the prices pull up to keep up with the demand.
When the supply of goods is low but the demand for them stays the same, that gives you cost-push inflation. When this happens, the prices are pushed up (usually by something cutting off the supply). Think back to when the global supply chain took a hit at the beginning of COVID-19, when the Suez Canal was blocked, and when the Colonial Pipeline was hacked. Sure, a lot of that was caused by people panic-buying, but it was still because of an event that caused prices to push up.
Increased Money Supply
At first, you might think having more money to go around would be a good thing. And yeah, that would be true if it were all in your own wallet. But having an increased money supply in the economy is part of what causes inflation to rise (because the supply of money is increasing faster than the rate businesses can produce goods).
When the rate that the dollar can be exchanged for goods drops, products imported from other countries become more expensive to buy. And you guessed it—that means the cost of those goods goes way up. In other words, a devalued dollar means that the dollar has less purchasing power than it did—so you pay more to get the same stuff.
What Is Inflation?
Okay, maybe you’re still wondering what inflation really is in the most basic of terms. So before we dig in more, let’s cover that: Inflation happens when prices go up and your dollar’s purchasing power (the value of money) goes down as time marches on. Basically, inflation makes prices shoot up and everything cost more.
Nowadays, we see lightning-fast inflation and prices on things like groceries and products are going up with every new trip to the store. But it wasn’t always like this. The Federal Reserve likes to keep inflation around 2% (if they can help it).1 And with the way the Fed influences interest rates, they usually do keep inflation hovering around that 2% goal. But with federal interest rates rising, only time will tell if the Fed’s tweaks will help at all.
How Does Inflation Work?
So, we know inflation happens when the prices of goods go up. But what causes the prices of things to go up anyway? It all goes back to supply and demand. When people want to buy things but there aren’t enough products for them to buy, the prices go up to meet the demand.
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But what’s the deal here? Why can’t a dollar today buy you as much as it did in 1955? Step into our economics class and we’ll try to walk you through it (without putting you to sleep).
Basically, that steady 2% inflation rate makes the value of that $20 bill in your pocket drop over time. Remember how your grandparents talked about how they could buy nickel candy and go see a movie for under $1? Must’ve been nice for them! Inflation is the reason we don’t pay the same prices for those things today.
What Is Causing Inflation Right Now?
Oh, boy—where do we even begin? Inflation has been on a steady climb since the economy bounced back from the pandemic. People left their houses (finally) armed with multiple stimulus checks burning a hole in their pockets. Post-pandemic folks were ready to spend, spend, spend. And all that money started swirling around the economy and kicked inflation into high gear.
Since then, we’ve seen shortage after shortage and supply issue after supply issue. Basically, there have been too few goods to go around (even though the demand for the goods is at a high).
Because of the shortages and supply chain problems, it has cost more to produce all the items people want. And companies have gone ahead and passed the bill right on to the consumer—sometimes even shrinking the product (but never the price tag). And guess what? People have just kept on paying the higher prices.
Oh, and one more thing—let’s not forget about the war in Ukraine either. Even though it’s true that inflation was happening long before the conflict, inflation numbers and gas prices have kept going in one direction since the war started—up.
How Is Inflation Measured?
Great question! Meet the Consumer Price Index. The CPI measures the average price of goods and services over time. It’s calculated by the U.S. Bureau of Labor Statistics (BLS) and is used to keep track of the prices of everyday expenses—things like gas, food and rent.
The September 2022 numbers show that inflation’s sitting at 8.2% over the previous 12 months.2 That’s the highest inflation rate in about 40 years! Sheesh. And thanks to the consumer price index, we’re able to see the way inflation changes from month to month.
Even though the Consumer Price Index won’t tell you what causes inflation, it can tell you a lot of other info—like the rise and fall of inflation numbers and how much prices jump on specific items like groceries. Want to know how much a carton of eggs costs this year compared to last year? The CPI will tell you all you need to know (and then make you want to invest in some chickens).
What Can I Do About Inflation?
Okay, now that we’ve covered all that, this is a good time to take a big, deep breath. Because the truth is, inflation happens. And even though it’s super annoying (and gets more annoying by the month), there’s no reason to lose your hope here. You won’t find that as a headline running on the nightly news. Shocker, we know.
If you really want to combat inflation, here are four ways to go to battle:
Okay, we know that’s easier said than done. But with inflation kicking into high gear, it’s more important than ever to try to cut costs where you can. Ditch the impulse buys, skip eating out, and cancel some subscriptions. Making just a few tweaks to what you spend each month can go a long way.
Invest Your Money
Investing is a great way to combat inflation because you’re stashing away your money and letting it grow at an annual rate that should beat the rate of inflation.
In other words, if you stick $500 under your mattress, it’s going to be worth less next year than it’s worth today. But if you invest that $500 and get an average return of around 10%, you turn that $500 into $550. The value of your money went up instead of down. Pretty amazing concept!
All right, investing is great and all—but remember, this is just for the Baby Step 4 and over crowd. Aka if you’re still in debt and saving up a fully funded emergency fund, hold off on investing until you’ve knocked that out. And once you have, reach out to a SmartVestor Pro to get all the insight you need about the investing process.
Make More Money
Call us old fashioned, but upping your income is a pretty good way to beat inflation. Maybe that comes from a raise, promotion or switching jobs for a better-paying salary. Or maybe it just means you finally start selling stuff you don’t use on Poshmark, eBay or Facebook Marketplace. Companies are hiring like crazy these days, and it’s a great time to pick up a second job on the weekends or drive for Uber or DoorDash. If you want to make an extra buck, you can totally do it.
Budget Your Money
Okay, so now you’re making extra cash to kick inflation in the face. Yay! Good for you! But now it’s time for the most important part: not spending all the cash you’re bringing in. It’s a little too easy to make more money and then just turn around and spend it. That’s why you need a budget to tell your money where to go each month (especially if you live in a state that’s dishing out inflation stimulus checks).
Making more money to cove high inflation prices won’t do you much good if you don’t make a plan for it. Our simple budgeting tool, EveryDollar, lets you give every dollar a name and take control of where your money goes. So, nice try, inflation. Better luck next time.