The word “inflation” isn’t typically used in very cheerful contexts. You won’t see headlines reading “Consumers dance in the streets to celebrate rising inflation!” — unless it’s April Fool’s Day, at least. But there is more than just the negative effect of inflation.
In fact, there are both positive and negative effects of inflation that you may notice. You probably experience a noticeable negative effect of inflation every time you go to the grocery store or fill your gas tank.
So what’s an example of a positive effect of inflation? On the macro level, it can function as a tool to rebalance the economy. On a personal level, periods of higher inflation can actually be an opportunity to build wealth.
How does it all work? Let’s learn about inflation and why it matters.
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How does inflation impact daily life and how is it measured?
In the simplest terms, inflation makes prices increase while your purchasing power decreases. These days, if you go into the dollar store with one dollar, you’ll leave empty-handed—because your dollar just isn’t worth as much anymore.
Price changes
We measure inflation by looking at exactly how much prices change. One of the most popular tools for this is called the Consumer Price Index, or CPI. Coordinated by the Bureau of Labor Statistics, the CPI looks at a collection of almost 100,000 goods and services that represent typical consumer spending patterns.
If the average price of apples increases nationwide, that’s just one item that gets factored in. Gas, airline fares, coffee, haircuts, insurance, and prescription medication are all part of the CPI too.
And if you’re like me and wondered about the weirdest things included in the CPI, we’re not the only ones: that list includes sewing machines, olives, and pastry tarts. Talk about specific!
Inflation isn’t the only thing that can cause prices to rise, so the BLS also controls its data for changes in size, quantity, or quality.
Average inflation rate
All this data is combined to generate an average inflation rate. That means if the current inflation rate is 8%, it doesn’t mean that everything you buy will be 8% more expensive than last year. Some things might be 20% more, and some might be 1% more, with a whole range of changes in between.
The negative effect of inflation: 5 Problems
Let’s jump into the bad news first and get it out of the way! The negative consequences of inflation are much more noticeable on a personal level because they tend to make life harder. Here are five ways this can happen.
1. Loans get more expensive
If you’re trying to get a new loan, inflation is definitely not your friend. Interest rates and inflation have a close relationship with one another. Typically, when one rises, so does the other.
One of the primary mechanisms behind this comes from the Federal Reserve. Also called the Fed, this is our central bank, and it is responsible for setting national interest rates.
During periods of high inflation, people might panic and try to spend as much money as possible before it loses more value. To prevent this from getting out of control, the Fed raises interest rates to temporarily disincentivize spending and borrowing.
Translation for you? If you’re trying to get a new mortgage, auto loan, personal loan, or other types of debt, it won’t come cheaply.
Ideas for getting a loan when inflation is high
When faced with this situation, you have three options:
- Wait to borrow until rates decrease
- Accept the current rate and plan to refinance your loan later
- Avoid taking out expensive loans by making extra money on the side (e.g., to buy a car in cash or learn how to save up for a house)
It’s up to you to weigh each option with the details of your own situation.
2. Salaries don’t always rise proportionally
Theoretically, life wouldn’t change at all if everyone got a raise that matched inflation. If inflation is 8% and you get a salary bump of 8%, you can still buy those apples you like without really feeling the price increase.
However, this is not what actually happens.
For example, in 2022, the inflation rate was around 9%, while wage growth trailed it at closer to 5%. Many employers don’t consider cost-of-living adjustments at all when determining raises, focusing solely on performance instead.
If your pay doesn’t rise to keep up with inflation, that’s effectively the same thing as a pay decrease. Under inflation, your purchasing power shrinks, and your paychecks may not stretch as far as they used to, which is a pretty negative effect of inflation.
How to combat higher costs of living
Don’t be afraid to learn how to ask for a raise in this scenario. If your company refuses to consider inflation when calculating an appropriate pay increase, it may be in your best interests to find a new job instead.
3. The cost of essentials rises (rent, food, gas, etc.)
Since the whole definition of inflation is essentially “things getting more expensive,” this might be the most prominent negative effect of inflation! During a period of high inflation, you can expect to watch your monthly expenses slowly creep upwards, even if you haven’t changed your spending habits.
It won’t happen all at once. If you’re a renter, your landlord might notify you of an increase. Then, you might find yourself surprised by the total at the grocery store and check your receipt to be sure there wasn’t a mistake.
You’ll go out to dinner with your family and wonder how the bill added up so fast when you didn’t even order that much. On the way home, you’ll stop for gas and wince as you fill up the tank (unless you’re a fellow Prius driver, at least!). Medical bills, insurance, and prescriptions all add up in life under inflation too.
These increases make it a lot harder to save money because it’s not like you can just stop eating or paying rent.
Don’t get discouraged! There are tricks you can use to find out how to go grocery shopping on a budget, how to ask for a discount, lower your car expense, and more.
4. Services become less affordable
There are a lot of services that don’t exactly count as the bare essentials but do enhance your life. When prices rise, these “nice-to-haves” are a prime target for making personal budget cuts.
Maybe your cable or streaming bill is on the rise: you can switch to cable alternatives.
Do you pay for a weekly cleaner? Find the motivation to declutter so there’s less to clean.
If you’re used to getting your hair and nails done frequently, make less frequent visits to the salon.
Some people might decide to visit the dentist less frequently, replace their glasses less often, or skip medical procedures that aren’t strictly necessary. But remember, health is your most valuable asset. Living a healthy lifestyle and preventative care can end up paying for themselves.
5. Non-essential businesses suffer
When the general public decides (or is forced) to curb their spending en masse, businesses take that hit.
Supporting businesses and being a business owner
This may impact you significantly if you’re a business owner in a non-essential industry. In the best-case scenario, you’ll be able to pivot in a more “inflation-proof” direction.
If you aren’t a business owner but enjoy supporting small businesses in your community, you may feel guilty about taking a break. And the reality is large corporations tend to have more power to weather these storms and keep prices lower.
Sadly, that means in a period of sustained high inflation, you may watch Main Street shrink as local businesses shutter. In fact, over half of small business owners reported that inflation was substantially impacting them recently.
Ultimately, your financial health still has to be your first priority. That said, when you need something, try to shop around and keep patronizing small businesses if the price difference isn’t huge.
The positive effect of inflation: 5 Outcomes
Now, let’s turn to some more cheerful news. Once you’ve made your plan to deal with the negative consequences of inflation, what are some of the ways it can work to your benefit? Here are five.
1. Your current debt becomes a better deal
Did you have any debt before inflation rates started to rise? Congratulations: in practical terms, it’s almost like you have less now.
Let’s assume you have a mortgage with a fixed interest rate and regular payment schedule. You’re still paying the same amount you did before inflation, and it doesn’t matter that your dollars are worth less now.
Inflation isn’t going to increase your payments because they’ve already been set for the entire term of the loan.
The same goes for student loans, business loans, or any other kind of loan. As long as it’s a fixed amount with fixed interest (learn about variable vs. fixed rate loans), your current debt is effectively shielded against inflation.
2. Interest rates on savings accounts increase
When the Fed raises interest rates, it doesn’t just affect borrowing rates. It increases savings rates too!
Thus, higher interest rates can qualify as positive and negative effects of inflation.
Now, it is still up to each individual bank how much interest they want to charge for loans or pay for savings. But banks that want to stay competitive usually stay in a similar range.
Types of accounts
There are several different types of interest bearing accounts. Some, like most checking and some standard saving accounts, barely pay any interest.
Keeping your money in any low-interest account is a bad idea during high inflation. Inflation slowly erodes the value of your money, so you want to choose an account that pays enough interest to help counter-balance that.
When you’re looking for a place to keep long-term savings like an emergency fund, high-yield savings accounts are the way to go. Online banks offer the highest interest rates since they have lower operating costs than brick-and-mortar establishments.
If you still want access to a physical bank, you can keep your local bank accounts and also open a new high-yield savings account online. Move your long-term savings there so inflation can’t hurt it as much.
Savings rates will often still be lower than inflation, so it’s not perfect, but if your account pays 4% APY while annual inflation is at 6%, you’re almost breaking even.
3. Unemployment drops when inflation rises
Inflation and unemployment traditionally have an inverse relationship. When people are employed, they spend, which drives inflation.
Overall, higher rates of employment are a positive thing. As long as you’re not in an inflation-vulnerable industry, you’ll have less worry about losing your job. On the other hand, finding a new job can become more difficult when there are fewer openings.
Keep in mind the employment landscape can quickly change if an inflationary period (and the subsequent response to it) triggers a recession. These economic slowdowns come with layoffs and higher unemployment. Periods of high inflation might be a good time to start training for a recession-proof job.
4. Market chaos can present investing opportunities
Economic instability can be scary, but if you keep a cool head about it, you can also view it as an opportunity. Inflation affects savings and investments in various ways. Companies that handle inflation well may see their stocks rise. Others may lose value or even go bankrupt.
Many long-term thinkers prefer investing in stocks when the market is unstable or low. The idea is that eventually, things should get back to normal, and your portfolio will bounce back. Some individual companies and stocks may fail, but if you start investing with index funds, you’re diversifying to protect your investments against that risk.
Beyond stocks, investments in real estate and commodities tend to thrive under inflation. As their prices rise, so do your profits. This is a big positive effect of inflation for anyone who owns property or has other assets increasing in value.
5. Inflation helps prevent deflation
As tough as inflation is to deal with, deflation comes with issues of its own. Deflation is the exact opposite of inflation: prices of goods and services decrease, and money’s purchasing power increases.
While this may sound attractive on the face of it, deflation generally signals an economic downturn. Periods of rapid or sustained deflation can lead to negative consequences like higher unemployment, lower wages, and more.
Since there are positive and negative effects of inflation and deflation, it’s important for them both to exist and balance each other. When either one seems like it’s getting out of control, the nation’s central banks aim to implement monetary policy that reins them back in. It’s a delicate balance!
Expert tip
Although many things become more costly when inflation is high, there are also good things, like higher interest rates and investing opportunities. The key is to figure out a way to make the current financial situation work for you, regardless of whether inflation is up or down.
Look for ways to increase your earnings and make the best spending choices possible, working with inflation instead of against it.
Some of the effects of inflation are very obvious, and one that you’ll likely notice right away is the cost of goods and services. It’s easy to see the price increase and notice how it affects your budget.
What are the biggest negatives of inflation?
Your purchasing costs rise even as your salary buys you less. In addition, loans are more costly, and small businesses may experience problems.
What are the best things about inflation?
Debt and interest rates provide better opportunities. Also, fewer people find themselves unemployed. In addition to all this, you may find chances for savings and investment during a time like this.
Above all, inflation helps to keep things balanced so that there isn’t too much deflation or inflation.
Related articles on inflation
Enjoyed this article on the effects of inflation? Here is some related content:
You can balance each negative effect of inflation with the positive ones by making a plan!
How will you and your family manage the consequences of inflation, like higher prices and interest rates? Do you understand more about how to prepare for a recession? Is there a particularly positive effect of inflation you think you can use to your advantage?
Check out this CGF live stream replay to hear Bola and Yazmir from Clever Girl Finance share their advice for making financial decisions during periods of high inflation and recessions!
