87% of American adults said inflation was their number one concern in 2022¹

What is inflation exactly? What are the effects of inflation on everyday life? And how can inflation affect your financial confidence?

Inflation is nothing new

Inflation is economic shorthand for a sustained rise in the prices for goods and services across the economy. Inflation is why life’s necessities like housing, groceries and haircuts cost more than they did last year or twenty years ago. In June 2022, inflation across all categories reached the highest rate since the early 1980s.² Among the reasons: lingering economic effects of the pandemic, supply chain disruption and global uncertainties.

When inflation soars, prices rise faster than incomes, and money starts to lose value. This can impact the financial confidence of millions of Americans, as even necessities like groceries become more expensive.

Some inflation is normal

Prices tend to rise over time, but the rate of inflation fluctuates.

High inflation:

• Prices rise
• Demand for goods and services drop
• Purchasing power is reduced
• Borrowing money is expensive

2% inflation:

• Prices are stable
• Demand for goods and services is high
• Unemployment is generally low
• The economy rolls along

0% inflation, or deflation:

• Prices decline
• Demand for goods and services has dropped
• Unemployment has increased / wages have fallen
• The economy has slowed and may be contracting

Here are some of the major typical effects of inflation when prices rise too fast:

Purchasing power is reduced.

Your dollars don’t stretch as far and it’s harder to stay on budget. The cost of food — a bellwether of inflation pain — rose 10% in 2022.⁴ And staples were especially hard hit: 26% more for a pound of butter⁵ and 31% more for eggs. ⁶

Gas prices are another painful example. When gas climbed above $5.00 per gallon in the US, many families had to curtail discretionary spending to afford the drive to work and school.

Money loses its value

A related effect of inflation is that money loses its purchasing power as prices rise. That’s why financial professionals advise against stashing your money away to “keep it safe.” If you put $100 in your sock drawer in 1990 and took it to the supermarket today, you’d return with only half the goods you could have bought 30 years ago.⁷ And the higher the rate of inflation is, the more purchasing power your money is losing.

Interest rates rise

Governments manage inflation by applying monetary policies. One tool they use is to raise interest rates in the hopes of slowing the economy and driving prices down. For example, when interest rates on car loans increase, consumers will be less inclined to buy a new car. Demand will fall and car prices may decline. But if you absolutely need to buy something on credit during a period of high inflation, that loan may cost you more.

Quality of life may suffer

When you’re worried about putting food on the table, anxiety is a normal reaction. Pervasive economic uncertainty lowers your confidence and psychological well-being. And there are fewer ways to relieve stress because everyday pleasures, like dining out, may be curtailed. Researchers have found that inflation can even cause error-prone thinking as people focus more narrowly on their basic needs at the expense of larger, long-term issues.⁸

Here are five ways to help maintain your financial confidence while managing a higher cost of living caused by inflation.

1. Review your expenses. Take a second look at your recurring bills, subscriptions, and other expenses. Look for subscriptions you aren’t really using and services you might be overpaying for, or could simply do yourself. Reducing your overall expenses is key step to maintaining overall standard of living.
2. Look for bargains. Paying inflated prices for essentials means hard choices, especially for consumers at lower income levels. Among the options: choose less costly brands or low-price substitutes, use money-saving shopping apps and loyalty cards, and buy in bulk. Even doing that, many consumers still have to carry higher credit card debt or borrow from savings to manage their monthly bills.
3. Avoid new debt. As mentioned previously, money loses value during periods of high inflation, and interest rates rise. This means your old debt will be relatively “cheaper” to repay after periods of high inflation than they were before it, and new debt — with a high interest rate — will be expensive. Try to keep your credit card balances low and delay unnecessary purchases.
4. Review your investment portfolio. Investment diversification is typically prudent, but it can be critical during periods of high inflation. High inflation causes bond yields to rise, making fixed income and money market funds more attractive. Diversifying by geography may help you offset falling returns in domestic stocks, say, with higher rates of return from international funds. Real estate can be a wise investment as a hedge against inflation and inflation-adjusted asset classes can help keep returns on an even keel as well.
5. Keep saving, even a little. Savings often take a double hit during periods of high inflation. You can’t contribute as much to your savings “bucket” because you have to shift those funds to pay for gas and groceries. And you may have to borrow from existing savings to meet other financial requirements. Reduced savings can make you particularly vulnerable in a financial crisis — ratcheting up your stress levels even more. While you may need to put off saving for the new home for a while, try to maintain monthly contributions to your emergency fund, even at a lower amount, and review the yields of savings accounts at your local banks, choosing a high-yield option if available — every little bit helps.

One final way to help maintain your financial confidence through a period of inflation is to prepare for the unexpected before it happens. Establishing a long-term financial strategy, meeting with a financial professional and contributing to your emergency fund are great ways to get started.

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2023-154453 Exp. 5/25