How does inflation affect the economy?
Originally Published 02 September, 2020, Updated in September, 2022
Have you been seeing that things are costing more today? Inflation has been creeping up the American economy. Understanding its effects is essential because the stock market and certain investments behave depending on the economic condition.
When the prices for food, freights, vitality, and different products and services rise, the whole economy is affected. This expectedly results in increasing prices, known as inflation. Here are some of the notable inflationary environments:
Impact to the cost of living
The cost of doing business
Government bond revenues, and every other aspect of the economy.
The consumer price index (CPI) was 2.3 in January 2020, Which implies overall prices increased by 2.3 percent over that last year. In theory, this means a vehicle that costs $30,000 in 2019 would cost $30,460 in 2020.
In July, 2022, the CPI year over year rose by 8.5%, and the inflation rate the month before was 9%. This is still a 40-year high.
The impact on buying power is the biggest tell-tale sign of inflation. Buying power is a measure of the number of products and services consumers could buy with a particular sum of money.
To put this simply, in 2019, $30,000 could have bought the vehicle from the above example – but in 2020, $30,000 does not have that same purchasing power. In 2022 the purchasing power is significantly less.
Adding to the ascent is a climb in the cost of gas, medical consideration, housing, and shelter (which incorporates ownership and rental costs). The CPI (consumer price index) records the rate at which the costs for specific items go up.
Inflation tracks the ascent in the cost of products and services, thus contracts the dollar’s buying power. At the point when inflation rises, consumers can buy fewer products, and productions costs thereby increase. Simultaneously, incomes and benefits go down. Therefore, the economy goes down during these times until stability returns.
Higher interest rates and rising costs of business make it harder to invest in old ways. Stocks are a great hedge against inflation because, in theory, a company’s income and profit rises at the same or higher rate than inflation.
In reality, however, inflation affects almost all areas of the economy and over time, it can take a bite out of your investment returns by providing you with less money to invest, if you have already lost money at the onset. The idea is the professional money managers don’t lose this chunk; but you have to invest with the top 5% of investors. This way your money team will keep your investments protected and be able to grow them further given the volatility in the market.
Your Boracchia Wiviott Wealth Partners are in this elite group of registered investment advisors who aren’t down like the mainstream firms. You can call or text us today for a complimentary consultation towards your best life: (424) 625 – 8943
Another notable point is you will find better yield on safe assets in inflationary times. You just don’t want to be taking on debt with the ability to increase interest rates in inflationary times (known as adjustable rate mortgages or variable loans with balloon payments.)
During highly inflationary periods, stocks overall do seem to be more volatile. Keep in mind the best and worst days in the market usually are within days of each other.
At the point when inflation is on the rise, income, or high-dividend paying stock costs generally decrease.
Blue chip stocks perform better in high inflation periods and growth stocks perform better during low inflation.
One can’t truly make guaranteed speculations regarding the inflation effect on equities, as various groups of stocks appear to perform unexpectedly.
How else can inflation affect investments in the stock market?
There are many ways inflation could affect your many investments.
Savings in a bank account is the biggest risk.
As we’ve touched on, inflation shrinks your reserves funds whether they’re in a savings account with an average interest rate or not.
In theory, when you’re working, your earnings should stay current with inflation. When you’re living off your investment funds, as in retirement, inflation lessens your purchasing power. It’s essential to guarantee you have enough resources to last through your retirement years.
However layoffs occur during times of inflation as well, as businesses can’t necessarily keep up the expenses that could during “better times.” Thus, be realistic about any raises or increases to your retirement plans.
Fixed income investments. While not right away, over time inflation helps you gain more yield for fixed-income investments, for example,
Commonly, investors purchase fixed income securities since they need a steady income stream in the form of interest payments.
However, since the rate of interest remains the same on most fixed income securities until maturity, the buying power of the interest payments decreases as inflation rises.
Stock investments. Truly, stocks have held up well against inflation. In theory, an organization’s earnings and revenues should increase at a comparative pace as inflation. This implies the price of your stock should rise along with the general prices of purchaser and producer goods.
How inflation affects real investment returns
Consider how three different rates of inflation affect the real return on a $1,000 investment with a 5% nominal interest rate.
A nominal interest rate of 5% + an inflation rate of 0% = a real interest rate of 5%
$1,000 investment X real interest rate 5% = a $50 real return gain.
A nominal interest rate of 5% + an inflation rate of 3% = a real interest rate of 2%
$1,000 investment X real interest rate of 2% = a $20 real return gain.
A nominal interest rate of 5% + an inflation rate of 6% = a real interest rate of 1%
$1,000 investment x real interest rate of 1 = $10 real return loss
Inflation and the stock market
One significant issue, though relatively ignored, is to measure the effect of inflation on the size and functioning of the stock market. Inflation overall helps the stock market. It could also give incentives for the government to repress investors during inflationary times through tax revenue so the rest of the country can keep up too.
But savers who have already paid taxes should be exempt from additional taxation when other opportunities exist for increasing revenues in the government such as optimizing efficiencies.
Inflation, Deflation, and Stagflation
Alot of policy occurs during times of change whether it be inflation, deflation or stagflation. These are major economic changes. As such, the government tinkers with the economy to establish what they feel is a healthy response to major transitions.
- Inflation is an overall increase of all costs in an economy, it means rising prices of goods and services and thereby resulting loss of purchasing power. We can see this misfortune when a fixed dollar amount purchases less of an item than it did before inflation.
- An extreme bout of inflation, where buying power drops definitely in a brief time frame, is known as hyperinflation and has occurred historically in different countries.
The objective of central banks, whether stated or not, is a fixed yet low rate of rising prices. In the U.S, for instance, the Federal Reserve system historically focuses on the rate of 2 percent, but in 2022 that is just not always possible. They thus have had to move with the times and have made it clear they want inflation to slow, which is why they have been raising the fed funds rate.
- Deflation is an overall decrease in all costs in the economy. Deflation is the opposite of inflation. It is defined as the falling prices of products and services in the economy. During the pandemic deflation spurred but it wasn’t something to get excited about; and as we know it didn’t last.
- An economy encountering stagflation faces rising costs and falling outcomes. A variation in price is determined by the relationship between the product and money, not by the value of the item. It is high inflation combined with low development and a consistently high rate of unemployment. As you may have guessed, this an unwanted combination. The U. S. experienced sessions of stagflation during the administrations of Ford and Carter and the US tries to avoid it through functions at the Federal Reserve.
Is buying gold and silver a good investment?
Everyone is interested in investing to keep up with inflation nowadays. We saw it starting to rear its head in 2020 and the fed was controlling it. However with all the economic bailout money, it was inevitable a period of inflation would ensue.
Both silver and gold have attractive features: gold is a good investment for the average valuable metals investor. Gold has a much bigger liquid market that is driven mostly by investment and also of course some jewelry demand.
Accordingly, silver can be appealing during down cycles when the cost of the metal is modest.
So, the most effective way to invest in silver and gold is to get one or more exchange-traded funds (ETFs). The key benefit is that they are incredibly liquid, and you can purchase or sell them at little or no cost since they are commission free but not active investment funds.
In times of deflation like we were in, gold or gold stocks in particular are your best friend. When inflation begins to rise, and especially at 40 year highs like we are in now, we will be ready for another sector.
To avoid erosion of your own purchasing power, and ensure your investments increase and don’t fall victim to the volatility inflation brings, call or text your Boracchia Wiviott Wealth Partners. We provide complimentary consultations. Call or text (424) 625 – 8943, we’ll be here for you anytime.