What is inflation, and why is it so important?
According to Wikipedia, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. This is important because as these prices increase, your dollar buys fewer goods and services. If we can’t buy as much stuff, our consumption based economy will slow down. That is why the Federal Reserve, whose purpose is to ensure economic stability, focuses largely on keeping inflation at 2%.
Why not 0%? The Federal Reserve wants to keep inflation above zero because inflation signals growth in the economy. If things cost a little more than sellers are making a little more money that they can, in turn, reinvest in the economy.Â The challenge is in measuring inflation.
How do you measureÂ inflation?
The Federal Reserve uses core inflation for planning purposes. Core inflation does not include volatile factors like food and fuel prices. When you strip food and fuel out of consumption measures, you are not getting a really accurate feel for what we are experiencing.
We are feeling a pinch in our pocketbook because headline inflation, which includes increasing food and fuel costs, is estimated to be 4.6% according to a Thomson Reuters/University of Michigan survey. To put it another way, a Facebook friend of mine appropriately noted that:
Lays Wavy Chips have shrunk to 10.5 ounces. They were 11 ounces a month ago. Orange juice got squeezed down to 59 ounces from the previous 64-ounce sizeâ€¦ He later went on to comment that Girl Scout Cookies are still a tremendous deal at $3.50 for 40 cookies!!! You say they only have 28 cookies now? I donâ€™t care, they taste great and the fundraising money helps the scouts!
The truth is that living costs are higher than we are being told. We wonâ€™t know exactly how much higher they are until after the fact.
What can we do?
The best thing we can do at this point isÂ to be conscious of where we are spending our money. You can track your spending easily for free at Mint.com.
I believe that the Federal Reserve is quietly discussing inflation combat techniques behind closed doors. The last time that we had any threatening inflation was in the late 70s early 80s. The Fedâ€™s biggest defense was and is increasing interest rates. As you may recall interest rates went from single to double digits really fast. I donâ€™t think weâ€™ll have double-digit inflation any time soon, but an increase in inflation, and in turn, interest rates, can have a big impact on your finances, especially if you have debt with variable interest rates.
If the Federal Reserve starts to raise interest rates like in the early 80’s, make sure you have a low interest fixed mortgage rate if you donâ€™t already have one. While most of my clients have no debt, if you do, it might not be a bad time to pay it off. Actually, it is always a good time to pay off debt.