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If you’ve tuned into the news at all in recent weeks, you may have started to be concerned about inflation effects on your finances. Inflation expectations are different now than they were in, say, 2008, when not only did the investment markets show impact but also jobless rates and wage stagnation.
So what does rising inflation mean for you as a homeowner? One major difference between the inflation the USA is currently experiencing and that of 2008 is that today’s inflation rate wasn’t caused by a housing market crash.
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What is inflation?
To understand the effects of inflation, it may be helpful to know what it is and what causes inflation. Inflation is often discussed when times are hard, and what we’re really addressing then is unusually high inflation.
Inflation simply refers to the rising prices of goods and services over time. If you think about how much it cost to buy a bag of flour in 1947 versus now, you understand that inflation is generally a constant in the USA.
However, when prices increase quickly or drastically for goods and services, it can result in higher prices for everything, including stocks, real estate, labor, and interest rates. When consumers are required to spend more money to sustain their lifestyles, these inflation increases may discourage borrowing and saving.
The Consumer Price Index
When purchasing power decreases, consumer spending follows suit. The Consumer Price Index (CPI) tracks inflation, measured by the percentage change in a group of goods and services. This inflation rate is commonly accepted and used as the measure of inflation across industries.
Economists also use the CPI to track annual inflation. Annual inflation is the percentage that the inflation rate has changed from the same month the previous year.
One of the primary effects of inflation has to do with consumer purchasing power. If you’re on a fixed income but prices rise for food and medicine, your fixed income is not going to stretch as far. You have less purchasing power.
High inflation erodes a consumer’s ability to spend money effectively. Economists often use “core inflation” — inflation aside from energy and food costs — because of how volatile those particular goods and services are. Consumers, though, can’t afford to ignore an overall decline in their spending power due to a broad rise in prices.
During an economic downturn, your purchasing power can be estimated by your “real income.” Real income is essentially your income after being adjusted for rising inflation. As inflation rises, you may find yourself dipping into the emergency fund in your savings account for expenses that otherwise would have been easy to cover.
Kinds and Causes
Although inflation itself is a relatively simple matter of the rising cost of goods and services, there are various reasons an inflationary environment gets out of hand. These are recognized as some of the top causes of high inflation.
Cost-push inflation occurs when price increases for labor and materials cause prices to increase at large. If an employer is paying more in wages and for the raw materials for their work, they’ll often pass that cost increase down to their customers by raising prices on their goods and services.
Demand-pull inflation occurs when there’s higher demand for goods than the supply can sustain. Shortages, like those that resulted from the Suez Canal blockage in 2021, push up the prices of those scarce goods, resulting in higher inflation. Large supply chain issues like that one cause aggregate demand to outpace overall supply.
Higher Costs of Doing Business
As seen in the description of cost-push inflation, when labor costs more, goods cost more. Companies use rising prices to make up for their higher costs of doing business.
These costs could be in the form of higher wages or more expensive infrastructure. A labor shortage might make companies advertise higher wages, thereby increasing costs. High oil prices could make shipping raw materials and finished products more expensive, a cost they’ll likely pass on to consumers.
Declining Exchange Rate
When a country’s money becomes less desirable in the global economy and the exchange rate decreases — a process called devaluation — they lose purchasing power in global financial markets. However, this decrease can spur demand for goods from that country, both within it and from without, as exports are less expensive to the buyers and imports cost more to the inhabitants of that country.
Therefore, devaluation can cause inflation in another country, as domestic goods become more expensive than foreign goods. The Federal Reserve, the central bank of the USA, has some inflation protection measures in place, but increased globalization makes devaluation difficult to address.
Outsized Money Supply
When the Federal Reserve increases the money supply, it means they allow more money to enter circulation. However, if the money supply — the amount of cash and bank balances — outpaces the production of goods, we see demand-pull inflation effects: high demand for products and low supply of them.
Laws & Policies
Rules and regulations can also affect the inflation rate. For example, tax subsidies may create demand for something before supply can catch up. An ecological regulation that limits the extraction of certain precious metals could represent that prices rise among cell phone manufacturers.
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What are the current inflation effects for homeowners?
As the pandemic took hold, the housing market took off. Demand for homes skyrocketed, but supply was still limited, so prices rose up and up and up.
When mortgage rates were still low, consumers were happy to borrow money for a new home, but when price hikes necessitated higher interest rates, homebuying began to cool. According to Forbes, “The Fed [the Federal Reserve] has been raising interest rates since March 2022, when they finally had to concede that inflation was no longer transitory.”
These higher interest rates discourage borrowing, especially when the price of buying a home remains high. At the moment, interest costs are still increasing, so a homebuyer who purchases sooner may still be in a better position than the end of the year.
What is the Federal Reserve doing with interest rates?
The central banks has been steadily increasing the federal interest rate to address the effects of inflation. Their aim is to maintain economic growth and a healthy economy while helping to control inflation.
The Federal Reserve System recognizes that high inflation hurts consumer spending, business interests, and the stock market. Sometimes, to manage inflation expectations, an interest rate hike is the best step the central bank can take.
However, the central banks have to be careful when managing the economy’s growth in this manner. They carefully monitor economic activity and labor statistics to support a minimum wage growth, stable overall prices, and positive future cash flows.
What does a higher inflation rate mean for me?
Many people are already seeing the effects of inflation as purchasing power declines, interest rates rise, and an investment portfolio sees fewer and fewer desirable stock prices and bond prices. The present value of your home may not mean much in the face of higher taxes and declining asset prices.
There are some steps consumers can take to ride out the effects of inflation until economic growth gets back on track.
Stay the Course, If You Can
If you don’t need to move house or refinance, it may be a good time to stay put. With interest rates on the rise and volatile economic activity, stable personal finances may require some patience.
For some people, as inflation rises, so does anxiety. The desire to do something in the face of rising inflation can be strong, but in some cases, the best way to weather the storm is to batten down the hatches.
New Ways of Investing
It could be that now might be a time to educate yourself on types of investment products that are more secure. One example would be Treasury Inflation-Protected Securities, or TIPS. TIPS are an investment product tied to the inflation rate: when inflation rises, the principal value rises.
The major benefit of TIPS is that when they mature, they cannot be worth less than the original principal, so even if inflation has decreased, you won’t have lost money by investing. If inflation has continued to go up, as it often does, you get the adjusted principal when the investment matures.
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Riding Out the Storm
For homeowners, talk of high inflation rates can be quite alarming. It may be hard to predict how rising prices will affect your home and livelihood.
Some people may find comfort in the knowledge that economic activity not static, but cyclical. Sometimes it’s better long-term financial decision-making to stick with what you’ve got, rather than making changes in the midst of uncertainty and volatility.