Inflation: It’s Here and You’re Paying for It!

Inflation as defined by the “Board of Governors of the Federal Reserve System” is:

“The increase in the prices of goods and services over time.”

I’m sure by now you’ve seen the headlines, paid the prices, and are wondering what is going on. Inflation rose through three quarters of 2021 and is continuing to rise in 2022. Adding to the inflation pressures are the Russia/Ukraine conflict and the sanctions placed on Russia. Without a quick resolution, inflation is going to stay higher for a longer period of time.

On Thursday, the most recent Consumer Price Index (CPI) data was released. According to the CPI, prices rose 7.9% over the last year. This is the highest reading in the index since the 1980’s. Concerning inflation, there are some things you can control, and there are some things you can’t control. Unless you’re getting a pretty big pay raise at work this year, your income will buy less this year due to inflation. Today, I’ll quickly cover why inflation is a concern, where it came from and what you can do about it.

Why is inflation a concern?

Prices rise over time. That is what we have mostly grown accustomed to and what the Federal Reserve wants. Prior to the pandemic, inflation in the United States was below 2% per year, so even if inflation decreases going forward, it may not come back below 2% for multiple years. The problem with persistently high inflation is the compounding increases in prices. Even if we assume inflation lowers from 7.9% to 5.5% by February 2023 and to 3.5% in February 2024, the average $100 item from 2021 would cost $117.82 in February 2024. Hopefully, inflation will decline to even lower levels, but we will only know the answer as time passes. The other concern with inflation is wages. Wages have been rising at the fastest pace in decades, but due to the high inflation, workers are still losing purchasing power, meaning their money buys less.

Where is inflation coming from?

Right now, the major drivers of inflation are supply chain disruptions, excess consumer demand, and elevated commodities prices (driven even higher by the Russia/Ukraine conflict). These reasons are all complimentary, which means having all three factors simultaneously drives inflation up even higher. I’ll briefly cover how each of these are contributing to inflation.

Two main factors are disrupting supply chains: (1) pandemic production and shipping disruptions and (2) increased demand from consumers. Every country reacted with different government-imposed restrictions around the world. Some countries shut down entire ports or factories if a single worker got sick. These actions are the primary reasons for delays in production and supply chains. Every delay in production and shipping for a single component contributing towards a finished product caused globally compounding delays, resulting in less finished products for sale (even in a normal demand environment). A large increase in consumer demand for goods, vice services, was created due the halt of the service industry starting in March 2020, causing a massive increase for goods supporting remote work, remote schooling, home improvements, and socially distant activities.

There are also two driving reasons behind the excess consumer demand: (1) a massive demand increase for consumer goods, especially in certain areas and (2) a massive influx of money to consumers in the form of stimulus checks, expanded unemployment benefits, child tax credit payments, and other government programs that provided citizens with extra money during the pandemic. As stated above, the shift away from services and towards goods was a large driver of increasing prices. More people (and money) began to chase the same amount or even fewer products than before, which drove prices higher and reduced the amount and frequency of discounts on the products.

Commodity prices across the board increased in 2021 and have accelerated in 2022, and those increases may continue into the future. Between drastically dropping oil demand, securing oil rigs, increasing barriers to produce new oil, then increasing oil demand and a global focus towards accelerating green energy adoption, energy prices are likely to stay high and potentially go (much) higher in the future. Higher energy prices bleed across prices for everything. Direct influences include rising gasoline, heating oil, natural gas (for heating, cooking, electricity generation), and jet fuel prices (plane tickets). Secondary and tertiary effects include shipping and transport costs, increased food costs (from shipping & fertilizer costs), petroleum products and derivatives, and others. The increased cost of many industrial metals will also cause green energy adoption costs to rise, whether through electric vehicle (EV) adoption or building solar panels, wind turbines, and batteries for energy storage.

How can you reduce the effects of inflation on your finances?

Like I wrote above, some things are in your control, and some things are not in your control. Basically, this comes down to your expenses, both your fixed and variable expenses. I’ll break down a few areas here, but more than anything, it may be time to cut down (or cut out) some of the money you spend on wants: clothing, entertainment, dining out, upgrading, etc. You can look at some of my previous posts (links below) for ways to reduce your expenses, especially while inflation is high.

Inflation is continuing to increase, and while the level of inflation may come down (from 7.9%), it is unlikely to return to below 2% for a long time unless the world goes into an economic recession. You should take a look at your spending and try to plan accordingly for the next year (or more) of increasing prices on everyday items.

“9 Ways to Cut Fixed Expenses”