Inflation has different effects on different things. For example, gas expenses may double while the value of your home decreases. That’s exactly what happened during the 2008 financial crisis. Home values have dropped nearly 20% in the last year.
Is everyone affected by inflation?
For much of the last two decades, economists and central bankers only mentioned inflation to emphasize how low it was. However, the discourse has altered after more than a year of accommodating fiscal and monetary policy in response to the COVID-19 pandemic. Official inflation measures have risen to levels not seen in decades in recent months.
The Federal Open Market Committee (FOMC) has expressed a stronger willingness to allow inflation to moderately exceed its 2 percent long-run target for some time following a period of inflation below target under the Fed’s new monetary policy framework introduced last year. The Fed has historically moved to avert inflationary pressures, but policymakers have stated that they will now wait until inflationary forces are evident in the statistics before changing interest rate policy. (See Econ Focus, First Quarter 2021, “The Fed’s New Framework.”)
“We want to see labor market conditions compatible with maximum employment, we want to see inflation at 2 percent, and we want to see it on pace to exceed 2 percent,” Fed Chair Jerome Powell said at a news conference following the FOMC meeting on April 27-28.
But which inflation indicators will the Fed officials be looking for? Inflation is usually characterized as a widespread and long-term rise in prices throughout the economy. However, prices rarely change at the same time for all commodities and services. Prices for lumber and secondhand vehicles, for example, have recently risen due to supply limits and rising demand. Furthermore, households spend money on a variety of items. As a result, an increase in inflation in particular products or services may have an uneven impact on households. Should central bankers take this into account when deciding on the optimal monetary policy stance?
In order to calculate inflation, you must keep track of what individuals buy and how much they pay for it. For any researcher, doing so for every purchase across the entire economy is a huge endeavor. In the nineteenth century, some American economists experimented with developing price indexes for a small selection of items. Following the establishment of the Bureau of Labor Statistics (BLS), then known as the Bureau of Labor, in 1884, the federal government started involved in pricing tracking.
According to BLS economist Darren Rippy’s 2014 history, the BLS began working on a cost-of-living index for families in 1888 by researching expenditures and retail prices. Presidents increasingly turned to the BLS at the turn of the twentieth century to mediate labor conflicts between industry and labor leaders and to track pricing increases during the two world wars. The Consumer Price Index, or CPI, was born as a result of this effort.
Although the CPI methodology has changed over time, the BLS’s underlying approach has stayed consistent. It uses surveys and on-the-ground research to ask households about the items and services they buy and to collect data on prices. The BLS creates a “market basket” of products and services based on this information in order to capture the consumption habits of the average urban household. Goods and services are grouped into one of eight broad categories and given weights based on their proportion of the average household budget. The total CPI measure of inflation gives more weight to price fluctuations for items and services that account for a bigger share of household spending.
The CPI has become the most extensively used and quoted inflation indicator in the United States. Firms consider it while deciding how to change their prices and wages. The CPI is also used by the federal government to update tax brackets and provide cost-of-living adjustments to assistance programs like Social Security.
However, the CPI has flaws that have led to the development of alternate price indices. The products that households buy aren’t always the same. Consumers react to price rises in some goods by switching to less expensive alternatives. If the price of beef rises, for example, consumers may purchase less beef and more chicken. The BLS does update its market basket on a regular basis, but with a lag, so the CPI doesn’t catch substitutions like this until much later. For example, the BLS used consumer survey data from 2015 and 2016 from the end of 2017 through the end of 2019.
When consumption habits change quickly, this might lead to measurement errors. The CPI underestimated inflation during the COVID-19 lockdown, according to a 2020 article by Harvard University’s Alberto Cavallo. This is because consumers spent more on inflationary items like food and less on deflationary items like fuel and transportation. According to Cavallo, actual inflation in the United States in September 2020 was 1.9 percent, compared to 1.4 percent according to the CPI, due to these changes in household consumption.
Other inflation measures, such as the Bureau of Economic Analysis’ Personal Consumption Expenditures (PCE) price index, seek to account for consumer substitutions while developing their market basket. In addition, the PCE uses different weightings for goods and services than the CPI.
Both the CPI and the PCE offer “core” inflation indices that exclude changes in food and fuel prices. While each of these categories play a significant role in many households’ budgets, their prices are more variable in the short term. Their inclusion in price indexes can muddle the long-run inflation signal, which is important for institutions like the Fed that are responsible for keeping long-term prices constant. Because of these factors, the Fed has used core PCE as its inflation benchmark since 2000.
Inflation indexes such as the CPI and PCE are designed to provide a single measure of inflation for the entire economy. Researchers aim to capture changes in the average household’s cost of living in order to do so. It should come as no surprise, then, that many households’ experiences differ from the average.
Households spend money on a variety of items and pay a variety of prices for the same goods and services. Low-income households spend a greater share of their income on core requirements housing, food, and transportation than higher-income households, according to the BLS Consumer Expenditure Survey, which analyzes expenditure by income and other demographic variables. Age has a significant impact on household spending and income. As people get older, they spend a larger percentage of their income on health care. Medical and educational costs have been rising faster than the cost of goods and services in general. As a result of these and other variances in spending, any particular household may experience inflation that differs significantly from the CPI or PCE figures. Indeed, the Bureau of Labor Statistics has developed an experimental CPI for older Americans, which reveals that they are more likely to face higher inflation. (See the graph below.)
Is everything affected equally by inflation?
Inflation is on the rise. It does not have the same effect on everyone. Rising costs, according to economists, can have a disproportionate impact on low-income households.
BYLINE: LAUREL WAMSLEY Over the last year, the consumer price index has climbed by more than 6%. Low-income families, for example, spend a larger percentage of their income on petrol than higher-income families. Even if this wasn’t the case…
JOSH BIVENS: It’ll still generate a lot more stress for lower-income families because they have a lot fewer adjustment margins to work with.
WAMSLEY: That’s Josh Bivens, the Economic Policy Institute’s director of research. He claims that growing prices in specific categories, such as food at home rather than restaurants, are more likely to effect low-income people.
BIVENS: Then there’s the main one: rent. Rent, after all, accounts for a much greater percentage of overall spending for low-income households than it does for everyone else. It is an absolute requirement.
WAMSLEY: According to the Federal Reserve Bank of New York, rents are predicted to jump 10% in the coming year. Republicans blame the Biden administration for rising prices, claiming that the president’s Build Back Better bill will compound the problem.
However, Arin Dube, an economics professor at the University of Massachusetts in Amherst, believes it’s critical to consider what’s happened to wages and inflation in the two years since the pandemic began.
WAMSLEY: During that time, he claims, inflation has increased by 7%, but earnings in the bottom fourth of the pay scale have increased by 10%. Because inflation was quite low during the onset of the pandemic, the time span had a considerable impact on the results. And, according to Dube, there has been particularly strong pay growth at the bottom in recent months, which is an unusual situation.
DUBE: Wage growth has been relatively slow at the bottom and middle for the previous 40 years, compared to significantly stronger growth at the top.
WAMSLEY: But, of course, these data are averages. And salaries aren’t rising for everyone.
Bryon Springer is a 38-year-old Army veteran. He works full-time in Stillwater, Oklahoma, for a tiny company that repairs computers and other electronic gadgets.
BRYON SPRINGER: My employer, on the other hand, does not believe in wage rises. I’ve been here for three years and still make the same $10 an hour that I did when I first started.
WAMSLEY: Springer is eligible for VA disability, which provides him with an additional $1,700 each month. He attempts to set aside a portion of his VA check for retirement and savings, but admits it’s difficult.
SPRINGER: My wage is shrinking every month as inflation eats away at it.
WAMSLEY: And housing expenses are a major concern for the younger generation.
Maria Gomez, a college student in Washington, D.C., is 19 years old. As a manager at a Mexican restaurant, she earns $17 an hour, which is roughly $2 more than D.C.’s minimum wage. Some of her pay goes toward her parents’ two-bedroom apartment, which she shares with them. She aspires to have her own apartment. However, given the city’s high housing expenses, it appears that she will be unable to do so by the time she graduates.
MARIA GOMEZ: I know that when I’m done with my education, I’m going to want to live on my own. However, I believe it will become quite difficult by the time I graduate. The cost of goods will undoubtedly rise. And that concerns me greatly.
DUBE: Increases in housing prices or rents are more likely to be baked in. And, unlike, say, petrol or food prices, they don’t reverse themselves quickly once they rise.
WAMSLEY: According to Dube, making broad forecasts about the future is difficult. However, if rents begin to rise rapidly and remain so, inflation could last longer and be more painful.
What impact does inflation have on ordinary people?
- Inflation, or the gradual increase in the price of goods and services over time, has a variety of positive and negative consequences.
- Inflation reduces purchasing power, or the amount of something that can be bought with money.
- Because inflation reduces the purchasing power of currency, customers are encouraged to spend and store up on products that depreciate more slowly.
Which group is the most impacted by inflation?
Wage earners in the informal sector with a set wage rate and retirees with fixed pensions are frequently the most negatively affected by inflation since their income remains constant but their expenditure rises owing to an increase in the general price level.
Is inflation a problem in all countries?
Exchange rates are relative, especially in today’s world of fiat currencies, when virtually no currency has any inherent value, such as that specified in terms of gold, against which it may be traded. The perceived worth of a country’s currency in relation to other countries’ currencies, or its domestic purchasing power, is the sole thing that gives it value. This condition can affect the impact of inputs on a country’s exchange rate, such as inflation.
When actual inflation falls short of expectations?
The unemployment rate in the economy will initially rise if the expected inflation rate does not surpass the actual inflation rate. The unemployment rate will only rise momentarily, and once the economy adjusts to the new inflation rate, it will return to normal. This occurs because businesses expect inflation will rise in the foreseeable future. Employees will argue for a similar wage increase if the predicted inflation rate is higher, so that they are prepared for the price increase. Employers will no longer be prepared to pay employees larger compensation when actual inflation is modest. As a result, the unemployment rate in the economy will temporarily rise.
Option an is erroneous because enterprises will not increase as projected since prices will not rise.
Option b is erroneous since this occurs when the actual inflation rate exceeds the anticipated inflation rate.
Why do the poor suffer from inflation?
According to my calculations, the lowest-income households are experiencing inflation at 7.2 percent, which is more than any other category. The rate of change was 6.6 percent for the highest-income families.
The gap between the two income categories grew significantly throughout 2021, starting at 0.16 percentage point and finishing at 0.6 percentage point, close to its greatest level since 2010.
The reason for the rising rich-poor inflation gap, often termed as inflation inequality by economists, is due to people’s typical spending habits in each income category.
During times of economic instability and crisis, most families choose to put off purchasing luxury items. However, most people are unable to cut back on essentials such as groceries and heating, despite the fact that wealthier customers are better positioned to stock up on these items while costs are low.
This shift in spending away from luxury things such as vacations and new automobiles and toward needs drives inflation higher for poorer households than for wealthier people. This is due to the fact that lower-income households spend a larger portion of their income on needs.
According to my research, the inflation gap is largest during recessions or in the early phases of economic recovery. The disparity in inflation rates between the lowest and highest income categories was close to one percentage point in the aftermath of the Great Recession of 2008-2009, which was bigger than it is now.
In times of economic development, however, the difference narrows for example, from 2012 to 2018. It even inverted at one point in 2016, with poorer Americans seeing nearly a half-percentage point lower inflation than wealthier Americans.
Increases in grocery and petrol prices were the primary cause of the widening difference in 2021. As a result, inflation has increased for all households. However, because poorer families spend a larger percentage of their income on food and energy, it has had a greater impact on them.
When petrol and grocery prices are removed from the equation, the inflation gap is dramatically narrowed.
Going forward, I expect the inflation gap to follow a similar trend as it did after the Great Recession: as the economy recovers and expands, low-income households will see lower inflation than high-income households.
What is creating 2021 inflation?
As fractured supply chains combined with increased consumer demand for secondhand vehicles and construction materials, 2021 saw the fastest annual price rise since the early 1980s.
What happens if inflation rises too quickly?
If inflation continues to rise over an extended period of time, economists refer to this as hyperinflation. Expectations that prices will continue to rise fuel inflation, which lowers the real worth of each dollar in your wallet.
Spiraling prices can lead to a currency’s value collapsing in the most extreme instances imagine Zimbabwe in the late 2000s. People will want to spend any money they have as soon as possible, fearing that prices may rise, even if only temporarily.
Although the United States is far from this situation, central banks such as the Federal Reserve want to prevent it at all costs, so they normally intervene to attempt to curb inflation before it spirals out of control.
The issue is that the primary means of doing so is by rising interest rates, which slows the economy. If the Fed is compelled to raise interest rates too quickly, it might trigger a recession and increase unemployment, as happened in the United States in the early 1980s, when inflation was at its peak. Then-Fed head Paul Volcker was successful in bringing inflation down from a high of over 14% in 1980, but at the expense of double-digit unemployment rates.
Americans aren’t experiencing inflation anywhere near that level yet, but Jerome Powell, the Fed’s current chairman, is almost likely thinking about how to keep the country from getting there.
The Conversation has given permission to reprint this article under a Creative Commons license. Read the full article here.
Photo credit for the banner image:
Prices for used cars and trucks are up 31% year over year. David Zalubowski/AP Photo
What impact does inflation have on your daily life?
Take out your wallet and pull out the PhP 50 bill. If you look at it closely, you’ll notice a sense of nostalgia. This bill is not the same as the one you had a decade ago. It definitely looks different, and the one you’re holding now isn’t worth the same as the PhP 50 you had back then, which was enough to get you a lunch at your favorite fast food joint.
Nowadays, your PhP 50 will only get you a little dinner, and how you wish you could travel back in time to when receiving PhP 50 from your parents was still exciting.
You may have figured out what causes the value of your money to depreciate. It’s a phenomenon known as inflation. Inflation, to refresh your mind, is the general increase in the prices of products and services over time, such as common foods, household goods, medical services, and transportation.
So, how does inflation affect your personal money, other from not allowing you to eat a lunch for PhP 50?
The rate of inflation fluctuates on a regular basis, and we rely on official data from the Philippine Statistics Authority, or Bangko Sentral ng Pilipinas, to establish how fast or slow it is. Between 1957 and 2011, the Philippines’ average inflation rate was 9.28 percent. 1
Let’s look at the cost of products and services in 2017 and 2018 to see how much inflation has affected your purchasing power. You’ll find that you have to pay much more for the identical stuff in only a year.
Assume a grocery bag including bread, fish, grains, meat, veggies, and fruits costing PhP 600 in 2017 costs PhP 631.2 in 2018. Similarly, if you paid PhP 500 in 2017 for water, electricity, and gas, the same services will cost PhP 526 in 2018. Other products, such as alcoholic beverages and tobacco, have witnessed comparable price increases. 2
When the cost of goods and services exceeds the amount of money you make, problems occur. Your purchasing power, or capacity to buy, decreases as a result. To keep up with the rising cost of living, inflation may require you to forego indulgences and “tighten your belt.” Small increases in spending can diminish your disposable income and, over time, erode the value of your savings.
Savings and investments do not always imply that your money is growing, particularly if the interest rate is lower than the rate of inflation. In fact, you could be squandering your hard-earned cash.
For example, if a business owner holds PhP 100,000 in a time deposit bank account earning 1% interest, the money will grow to PhP 101,000 the next year. If the inflation rate is 4.4 percent 3, the value of his/her money will only be PhP 96600the PhP 1,000 you acquired will not be enough to compensate for the PhP 4,400 worth lost due to inflation.