Understanding inflation and its impacts is key to knowing how external factors can influence your finances. Inflation is a complex phenomenon that affects all parts of the United States and world economies. Several factors cause this phenomenon, which can impact individuals in numerous ways. Read on to learn more about inflation, its causes, and how it can affect you.
What is Inflation?
Inflation is a sustained increase in the general level of prices for goods and services in an economy over a certain period. In other words, it is a measure of how much more expensive things have become over time.
As inflation rises, the purchasing power of each dollar decreases. This decrease means that each dollar you have in your wallet or bank account buys less than it did before. For example, if the rate of inflation is 4%, then something that cost $100 last year will cost $104 this year.
What Causes Inflation?
Several factors can cause inflation, including a money supply increase, economic growth, and changes in supply and demand. Inflation can also be caused by increased government spending, as this can lead to higher prices.
Money Supply
The most common cause of inflation is an increase in the money supply. When the money supply increases faster than the demand for goods and services, it leads to higher market prices. This occurrence is known as demand-pull inflation.
Increased Government Spending
Increased government spending can also lead to inflation. Increased spending occurs when the government spends more than it takes in, causing an increase in the money supply. This incident is known as cost-push inflation.
Cost of Production Changes
Changes in the cost of production is another factor that causes inflation. When production costs increase, it may force businesses to raise prices to cover their costs. Rising costs of raw materials, energy, or labor all contribute to this type of cost-push inflation.
Changes in Consumer Preferences
Lastly, changes in consumer spending preferences can lead to inflation. When consumers demand more of a certain product or service, businesses may raise prices to meet the increased demand. This occurrence is another example of demand-pull inflation.
What Are the Impacts of Inflation?
Inflation has many impacts on the economy and individuals, as well as currency exchange rates and tax prices.
Individual Impacts
For individuals, inflation means that the purchasing power of their money decreases over time. This decrease can cause an increase in the cost of living and make it more difficult to save and invest for the future.
Economic Impacts
For the economy, inflation can have both positive and negative impacts. On the positive side, it can lead to increased economic activity, as people are more likely to spend their money when prices are rising. On the other hand, inflation raises interest rates, which can discourage investment and lead to slower economic growth.
Impacts on Exchange Rate
Inflation can also impact the exchange rate of a country’s currency. If a country has high inflation, then the value of its currency will decrease relative to other currencies. A currency decrease can make the country’s exports more expensive, leading to a decreased international demand for them.
Impacts on Taxes
Inflation may lead to higher taxes as well. As prices increase, the government may need to increase taxes to cover the raised cost of providing services. Increased taxes can cause decreasing disposable income, making it more difficult for people to save and invest.
Plan For Inflation with An Experienced Financial Advisor
Understanding inflation and its impacts is a crucial aspect of financial planning. If you need help creating a plan that accounts for this possibility, the financial advisors at Wellspring Financial Partners can help. We will work with you or your business to establish a successful financial future.
Set up an appointment with one of our financial advisors by contacting Wellspring today.
Wellspring Financial Partners, LLC does not provide tax or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
