Price increases could be a sign of a fast-growing economy. Demand for products and services is fueled by people buying more than they need to avoid tomorrow’s rising prices. Suppliers are unable to keep up. Worse still, neither can wages. As a result, most people are unable to afford common products and services.
What effect does inflation have on a person?
- 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.
How does inflation effect people’s living standards?
Inflation has an impact on your standard of living since it lowers your purchasing power. Because many retirees live on a fixed income, inflation has a significant impact on them. Prices grow while their pension income remains unchanged. As a result, their disposable income is diminished as day-to-day expenses eat up an increasing amount of their earnings.
If wages remain stagnant or if inflation outpaces wage increases, wage earners face the same challenge. If your income rises faster than the rate of inflation, you will avoid the effects of inflation.
Is everyone affected 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.
Who are the people who are impacted by inflation?
Inflation is defined as a steady increase in the price level. Inflation means that money loses its purchasing power and can buy fewer products than before.
- Inflation will assist people with huge debts, making it simpler to repay their debts as prices rise.
Losers from inflation
Savers. Historically, savers have lost money due to inflation. When prices rise, money loses its worth, and savings lose their true value. People who had saved their entire lives, for example, could have the value of their savings wiped out during periods of hyperinflation since their savings became effectively useless at higher prices.
Inflation and Savings
This graph depicts a US Dollar’s purchasing power. The worth of a dollar decreases during periods of increased inflation, such as 1945-46 and the mid-1970s. Between 1940 and 1982, the value of one dollar plummeted by 85 percent, from 700 to 100.
- If a saver can earn an interest rate higher than the rate of inflation, they will be protected against inflation. If, for example, inflation is 5% and banks offer a 7% interest rate, those who save in a bank will nevertheless see a real increase in the value of their funds.
If we have both high inflation and low interest rates, savers are far more likely to lose money. In the aftermath of the 2008 credit crisis, for example, inflation soared to 5% (owing to cost-push reasons), while interest rates were slashed to 0.5 percent. As a result, savers lost money at this time.
Workers with fixed-wage contracts are another group that could be harmed by inflation. Assume that workers’ wages are frozen and that inflation is 5%. It means their salaries will buy 5% less at the end of the year than they did at the beginning.
CPI inflation was higher than nominal wage increases from 2008 to 2014, resulting in a real wage drop.
Despite the fact that inflation was modest (by UK historical norms), many workers saw their real pay decline.
- Workers in non-unionized jobs may be particularly harmed by inflation since they have less negotiating leverage to seek higher nominal salaries to keep up with growing inflation.
- Those who are close to poverty will be harmed the most during this era of negative real wages. Higher-income people will be able to absorb a drop in real wages. Even a small increase in pricing might make purchasing products and services more challenging. Food banks were used more frequently in the UK from 2009 to 2017.
- Inflation in the UK was over 20% in the 1970s, yet salaries climbed to keep up with growing inflation, thus workers continued to see real wage increases. In fact, in the 1970s, growing salaries were a source of inflation.
Inflationary pressures may prompt the government or central bank to raise interest rates. A higher borrowing rate will result as a result of this. As a result, homeowners with variable mortgage rates may notice considerable increases in their monthly payments.
The UK underwent an economic boom in the late 1980s, with high growth but close to 10% inflation; as a result of the overheating economy, the government hiked interest rates. This resulted in a sharp increase in mortgage rates, which was generally unanticipated. Many homeowners were unable to afford increasing mortgage payments and hence defaulted on their obligations.
Indirectly, rising inflation in the 1980s increased mortgage payments, causing many people to lose their homes.
- Higher inflation, on the other hand, does not always imply higher interest rates. There was cost-push inflation following the 2008 recession, but the Bank of England did not raise interest rates (they felt inflation would be temporary). As a result, mortgage holders witnessed lower variable rates and lower mortgage payments as a percentage of income.
Inflation that is both high and fluctuating generates anxiety for consumers, banks, and businesses. There is a reluctance to invest, which could result in poorer economic growth and fewer job opportunities. As a result, increased inflation is linked to a decline in economic prospects over time.
If UK inflation is higher than that of our competitors, UK goods would become less competitive, and exporters will see a drop in demand and find it difficult to sell their products.
Winners from inflation
Inflationary pressures might make it easier to repay outstanding debt. Businesses will be able to raise consumer prices and utilize the additional cash to pay off debts.
- However, if a bank borrowed money from a bank at a variable mortgage rate. If inflation rises and the bank raises interest rates, the cost of debt repayments will climb.
Inflation can make it easier for the government to pay off its debt in real terms (public debt as a percent of GDP)
This is especially true if inflation exceeds expectations. Because markets predicted low inflation in the 1960s, the government was able to sell government bonds at cheap interest rates. Inflation was higher than projected in the 1970s and higher than the yield on a government bond. As a result, bondholders experienced a decrease in the real value of their bonds, while the government saw a reduction in the real value of its debt.
In the 1970s, unexpected inflation (due to an oil price shock) aided in the reduction of government debt burdens in a number of countries, including the United States.
The nominal value of government debt increased between 1945 and 1991, although inflation and economic growth caused the national debt to shrink as a percentage of GDP.
Those with savings may notice a quick drop in the real worth of their savings during a period of hyperinflation. Those who own actual assets, on the other hand, are usually safe. Land, factories, and machines, for example, will keep their value.
During instances of hyperinflation, demand for assets such as gold and silver often increases. Because gold cannot be printed, it cannot be subjected to the same inflationary forces as paper money.
However, it is important to remember that purchasing gold during a period of inflation does not ensure an increase in real value. This is due to the fact that the price of gold is susceptible to speculative pressures. The price of gold, for example, peaked in 1980 and then plummeted.
Holding gold, on the other hand, is a method to secure genuine wealth in a way that money cannot.
Bank profit margins tend to expand during periods of negative real interest rates. Lending rates are greater than saving rates, with base rates near zero and very low savings rates.
Anecdotal evidence
Germany’s inflation rate reached astronomical levels between 1922 and 1924, making it a good illustration of high inflation.
Middle-class workers who had put a lifetime’s earnings into their pension fund discovered that it was useless in 1924. One middle-class clerk cashed his retirement fund and used money to buy a cup of coffee after working for 40 years.
Fear, uncertainty, and bewilderment arose as a result of the hyperinflation. People reacted by attempting to purchase anything physical such as buttons or cloth that might carry more worth than money.
However, not everyone was affected in the same way. Farmers fared handsomely as food prices continued to increase. Due to inflation, which reduced the real worth of debt, businesses that had borrowed huge sums realized that their debts had practically vanished. These companies could take over companies that had gone out of business due to inflationary costs.
Inflation this high can cause enormous resentment since it appears to be an unfair means to allocate wealth from savers to borrowers.
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 are the benefits and drawbacks of inflation?
Do you need help comprehending inflation and its good and negative repercussions if you’re studying HSC Economics? Continue reading to learn more!
Inflation is described as a long-term increase in the general level of prices in the economy. It has a disproportionately unfavorable impact on economic decision-making and lowers purchasing power. It does, however, have one positive effect: it prevents deflation.
What impact does inflation have on a family?
Furthermore, we estimate that lower-income households spend a larger portion of their budget on inflation-affected products and services. Households with lower incomes will have to spend around 7% more, while those with better incomes would have to spend about 6% more.
How does inflation effect the average person?
Answer: Prices of everyday things such as food, fuel, electricity, clothing, and house maintenance services rise slowly, but the average person’s income remains constant or at most meets the inflation rate.
What effect does inflation have on income?
Wage-earners and Salaried People People on fixed incomes suffer a lot during inflation since the rate of increase in earnings is always slower than the rate of increase in prices. As a result, inflation reduces the real purchasing power of persons who earn a fixed salary.
Is there a difference in how inflation affects different people?
Naturally, not everyone uses medical services at the same time. The authors highlighted a 2004 study that discovered roughly half of all lifetime medical expenses arise beyond the age of 65. 1 They stated: “Furthermore, the amount of money spent on medical services is influenced by health insurance coverage. Rising costs are closely related to out-of-pocket medical expenses for persons without health insurance. And, in terms of total revenue, the cost increases could be enormous.”
Inflation, core inflation, and housing services inflation are all still lower than before the 2007-09 recession, according to Chien and Morris, albeit medical services inflation is greater. They stated: “Inflation has recently been on the rise, and if rates continue to rise, different segments of the population will be impacted more than others.”