If you grew up in the 1970s and early 1980s, inflation may be one of the monsters in your economic worry closet. You probably remember the gas rationing and skyrocketing prices for everything from the Hamburger Helper to halters.
The recent surge in the Consumer Price Index for All Urban Consumers (CPI-U), the government‘s main indicator of inflation, has probably made you jump a bit too. The prices of hotel rooms, gasoline and even bacon have risen sharply over the past 12 months.
But why all the fuss? What is inflation, what causes it, what cures it and how much should you worry about it now? Here is an overview of inflation and some tips for managing it.
What is inflation?
Simply put, inflation is a rise in prices. The most commonly used inflation index, the CPI-U, measures the average change in prices of a basket of goods likely to be purchased by people living in cities and suburbs. The index has grown an average of 3.2 percent per year since 1914, according to the Bureau of Labor Statistics, which maintains the index.
The most recent reading of the index was certainly above average: the CPI-U rose 4.2% in the 12 months ending in April, its biggest 12-month increase since September 2008. Its April’s one-month gain of 0.8% was the largest since 2009.
Your experience with inflation is likely different from that reflected in the CPI-U, which weights each item according to a formula meant to reflect the average household. If you’ve got kids in college, big medical bills, or a greedy appetite, your cost of living has probably gone up more than the CPI. Conversely, if your kids flew into the nest and you have low medical bills, your cost of living has probably increased less than the CPI.
What causes inflation?
A simple definition of inflation is too much money for too little goods and services. Sometimes the economy accelerates so quickly – due to either low unemployment or government spending, or both – that cash-filled consumers will push prices up and employers raise wages to keep up with the hike. prices. In the late 1960s, for example, unemployment fell to 3.4% and inflation rose to almost 6%.
Another way inflation rises is when a sudden shortage of a key material, like oil, drives prices up. In 1973, the Arab oil embargo significantly reduced the supply of oil. People lined up for hours to fill up on gas, and in 1974 the federal government imposed a speed limit of 55 miles per hour to save fuel. The CPI rose 6.2% in 1973 and 11% in 1974.
War often sparks inflation: the CPI rose 18% in 1918, thanks to shortages of everything from cans to copper during World War I. In 1942, as World War II warmed, the CPI rose 10.9%. The era of the Vietnam War combined an overheated economy and massive public spending, which fueled another inflationary spiral. The CPI jumped 13.5% in 1980 and registered an average annual increase of 8.5% from 1972 to 1981.
What are the effects of inflation?
The obvious effect of inflation is that it makes it harder to pay for necessary things. For anyone on a fixed income, like a pension or Social Security, inflation means your monthly payments buy a little less each month. Some people find themselves forced to switch to cheaper cuts of meat, turn down the thermostat in the winter, or even skip medication doses.
A less obvious effect of inflation is rising interest rates. Bankers who lend at 3% will lose money – adjusted for inflation – if inflation is 4%. Typically, when inflation begins to rise, the interest rates charged on mortgages and other loans also increase. For savers, returns on bank CDs and money market funds will generally increase as well, but perhaps less rapidly.
Inflation is cumulative, as prices rarely drop after rising. A monthly payment of $ 100 will have purchasing power of about $ 82 after a decade of inflation of just 2%. Because of the long-term effect of inflation on retirees, Congress in 1975 authorized annual cost-of-living adjustments for Social Security recipients.
Uncontrollable inflation, usually aided by central banks continually pumping more money, is called hyperinflation. In Germany in 1923, for example, consumer prices doubled every few days. During these times, people often exchange their money for more stable currencies or gold, and political unrest is common: the instability of the German economy in the 1920s was one of the reasons Adolf Hitler came to power.