• Harry N. Stout

313- Five Questions About Inflation


Data recently released by the Bureau of Labor Statistics showed that inflation had climbed 8.5 percent in March compared to a year ago — the largest increase since 1981. There were gains nearly across the board, with energy, shelter and food prices all soaring at record rates. Exactly how much inflation you are experiencing depends on where you live. Fidelity Investments just published a national chart that shows the amount of year-over-year inflation for March 2022 you have experienced.


Here are five most frequently questions individuals have about inflation:


1. What is inflation?

Per Investopedia, inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.


Inflation can be contrasted with deflation, which occurs when the purchasing power of money increases and prices decline.


2. How is the rate of inflation calculated?

The index of the change in consumer prices or inflation that we see in the media is calculated by the Bureau of Labor Statistics (BLS). The index that is referenced in the headlines you read is the broadest and most comprehensive. It is called the All-Items Consumer Price Index for All Urban Consumers (CPI-U). In addition to the CPI-U index, BLS publishes thousands of other consumer price indexes, such as the CPI-U less food and energy. Some users of CPI data use this index because food and energy prices are relatively volatile, and they want to focus on what they perceive to be the "core" or "underlying" rate of inflation.


3. How are price changes determined?

The CPI, generated using sampling techniques, represents the price changes for all goods and services purchased for consumption for the specific index. BLS has classified all expenditure items into more than 200 categories, arranged into eight major groups (food and beverages, housing, apparel, transportation, medical care, recreation, education and communication, and other goods and services). Included within these major groups are various government-charged user fees, such as water and sewerage charges, auto registration fees, and vehicle tolls. As you can see the categories used in the calculation are quite comprehensive and cover all aspects of the goods and services we buy.


4. What factors are driving inflation?

Experts say there are three main factors driving the increase in prices: sharply rising labor costs, energy prices and interest rates. Also impacting the number are global supply chain issues and the geopolitical impacts of the war in Ukraine. Each one of these items pushes the cost of everyday consumer goods higher, and it will take a complex set of forces to return to pre-pandemic normal.


5. Why is inflation important to my money?

Inflation causes the cost of goods and services to increase. If your income does not keep pace with the increase in prices you will need to make decisions about how to address the difference. This could mean lifestyle changes, spending cuts, substitution of goods and a realignment of your savings and investments to keep up with the decline in purchasing power of the dollar. For example, it has been reported that overall wages for the last year have increased 5.6%, which is substantially below the 8.5% reported increase in inflation.


Summary

Welcome to the inflationary world of today. Over the next several years inflation will be a key financial issue in our day-to-day lives. For younger Americans, who have not had to deal with in their financial lives, it will be a new experience. For baby boomers it will bring back memories of the 1970’s. Whatever age group to which you belong, you will need to understand and manage the impact of inflation on your financial life.

 

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