We’re pretty sure you’ve heard the term ‘inflation rates’ being thrown around a lot in the media and general conversation lately. If you’ve only recently had to start paying for your own expenses or you aren’t up to date on financial lingo, it’s important you have a basic understanding of how inflation rates can impact your budget and expenses. We’ve gathered all the things you need to know about inflation rates to get you up to speed.
1. Inflation rates are at record highs
In June 2022, inflation rates in the USA reached highs that haven’t been recorded since 1981, a 9.1% increase from the previous year. This was 0.3% higher than the 8.8% economists had predicted for the same period. While this doesn’t sound like a lot, think about what that increase means for basic goods and services… it starts adding up quickly.
2. Inflation rates are transitory
The good thing about inflation rates is that they are constantly in flux and very rarely remain stagnant. Inflation rates rise when the demand for goods and services exceed supply or supply is constrained. Very low inflation rates are also not good for the economy as this means there is limited GDP growth, less demand for goods which leads to reduced revenue and lower salaries for employees. The point we are making is that while inflation rates might be high now, they will go down again as the factors that drive them change.
3. The Covid-19 pandemic is largely to blame
The current high inflation rates we see are largely due to the effects of the Covid-19 pandemic, it has devastated economies and businesses across the globe. The pandemic caused supply chain disruptions and labor shortages with stay-at-home orders, resulting in reduced capacity to produce goods. This has driven the costs of a number of products much higher than pre-2020 as demand exceeds supply. A prime example is the increased demand for microchips, as more businesses introduce automation and smart technology to their products, and how an inability to receive parts or run production at full capacity led to global shortages. This has had the biggest impact on the automotive industry with stock shortages and much higher prices for new and used vehicles.
4. The Ukraine war has also driven costs higher
In March 2022, Russia invaded Ukraine and as world leaders imposed sanctions on Russia, the US was rocked by further supply chain disruptions. The US relies heavily on the Ukraine and Russia for neon gas, palladium and pig iron. With the Ukraine unable to export and Russia cutting the USA off, there have been extensive shortages. Below are some sectors of the economy that have been affected by these shortages:
Pig iron – Airplane manufacturing, transportation, auto parts, auto manufacturing
Palladium – Auto parts, auto construction, transportation, electronics manufacturing, IT services
Neon gas – Aviation, auto parts, auto construction, auto telecoms, electronics manufacturing, IT services
5. Food, energy and housing costs are primary drivers of inflation
While many factors contribute towards inflation, food, energy and housing costs are the largest contributors. Food and energy costs are always interconnected. As fuel, electricity and transportation costs surge, it becomes more expensive to produce food, so the prices go up. Raw material shortages such as wheat and corn have a widespread impact when it comes to driving prices higher. These commodities are used in plenty of commercial food products, including pet and animal food. If you were wondering why egg prices have shot up, think about how much more it is costing farmers to feed their chickens.
In the same way, as the population grows rapidly, there is an increased demand for housing and an inadequate supply as well as higher interest rates which can leave home buyers in debt. This drives the prices of rentals, sales and new builds much higher than they previously were, making it one of the biggest expenses for most households.
6. Government spending exacerbates inflation rates
The government and its spending policies can also directly impact inflation rates as poor investment decisions can cause investors to pull out of the country and weaken the dollar. A weaker currency will always drive up inflation due to instability and uncertainty.
7. Inflation erodes consumer purchasing power
High inflation rates take away your purchasing power as a consumer. You are left with less choice, higher prices and less disposable income to actually make purchases. This is because when inflation rates soar rapidly, most companies are unable to keep up with the increases and salaries do not match the costs of living.
Hopefully you can walk away with a better understanding of what inflation rates are, what drives them and how they affect your cost of living. The more you understand their impact on you and the economy, the more proactive you can be in mitigating their effect on your finances.