What Causes Inflation?

What Causes Inflation?
What Causes Inflation?
| May 19 2022
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The Whats and Whys of Economic Inflation in 2022

Inflation has been a hot topic of conversation lately, and for good reason. Inflation is the highest it’s been in nearly four decades, and it’s affecting every part of our day to day lives.

Today’s inflation is exacerbating many people’s money issues, causing more and more strain on many household budgets and leaving many on the hunt for ways to save money. But what exactly is inflation, and why is it rearing its ugly head now?

Today we are talking all about inflation – what it is, what causes it, and how you can protect your money.

What is Inflation?

Inflation is the increase in the price of goods over a period of time. It is natural and can be a good thing – to a certain extent. Economists believe that a little inflation signifies a healthy economy with healthy supply and demand. If consumers believe prices will rise slightly, they are more apt to spend their money at present. There is no cut and dry rule for what constitutes healthy inflation, but economists and policymakers generally accept that 2% inflation is acceptable.

When inflation gets out of hand and starts exceeding the 2% mark, that’s when the economy takes more of a hit. Our current inflation rate is around 8%, quadruple what it should be. So what caused this drastic change?

What Causes Inflation?

Inflation has many causes, some of which are more complex than others. In general, these causes can be broken down into two categories: demand pull inflation and cost push inflation.

Demand Pull Inflation

Demand pull inflation is when the demand for items is greater than the supply of those items. When demand gets ahead of supply, prices increase as upward pressure is applied. Here are a few causes of demand pull inflation:

  • Marketing and New Technology. When a new product or new tech comes out, the demand usually outweighs the supply, resulting in demand pull inflation.
  • Growing Economy. When the economy is growing and expanding, unemployment tends to drop and people have more money in their pockets. This results in increased demand for items, and therefore an increase in prices.
  • Government Regulations. Certain government regulations, such as tax subsidies, can cause demand to rise. If that demand is higher than the supply levels, demand pull inflation can occur.
  • Expanded Money Supply. If the Fed prints money at a higher rate than the economy is growing, then more money is in circulation. Since there is more money in circulation for the same amount of goods and services, demand pull inflation occurs.

Cost Push Inflation

Cost push inflation occurs when the cost of materials and wages increases. These costs are then passed on to the consumer, resulting in inflation. Here are a few causes of cost push inflation:

  • Supply chain issues. When materials are scarce, the cost of the materials will increase due to supply and demand. This is one of the main contributors of our current hyper-inflation. 
  • Rising wages. When wages increase, either as a result of government regulation or as a result of competition for workers, it results in a higher cost of production. It is important to note that this is a debated area in the world of economics. Many economists believe that higher wages across the nation will cause an increase in demand that can offset inflation.
  • Government regulations. Certain government regulations, such as building regulations and tariffs, can cause the cost of production to rise, costs that are then passed on to consumers causing cost push inflation.
  • Change in exchange rate. If the value of the U.S. dollar loses value in relation to foreign currency, imported goods become more expensive to buy. Since most products in the United States are imported, this causes cost push inflation.

Our current drastic inflation is a result of both demand pull inflation and cost push inflation. 

Is Inflation Good or Bad?

While it a little inflation, as mentioned above, can be ok, there are definitely some downsides. Let's look at the possible consequences of inflation.

When inflation occurs, it causes a decline in purchasing power. This leads to a cycle where: 

Consumers spend less money → Businesses cut back on investing and hiring → Higher unemployment rates and reduced spending 

The bottom line is that when inflation occurs, it can be hard to get out from under. 

But what does this mean for you? Inflation has three major effects on consumers in their everyday lives:

  1. Products are more expensive. Prices rise due to increased wages, supply chain issues, and lowered exchange rates. Money does not stretch like it used to, putting more of a strain on everyone’s budgets.
  2. Loan interest rates increase. Interest rates increase in part because of the Fed’s response to inflation. To cool down the economy and curb inflation, the Fed decided to increase the fed funds rate earlier this year. This rate serves as a benchmark for interest rates nationwide. This makes it harder and more expensive for people to buy houses, cars, and get personal loans. 
  3. Returns on savings decrease. Savings account interest rates hovers just above 0%, so any interest that you might accrue is quickly outpaced by inflation. 

In short, every dollar matters more than ever in times of inflation. 

What Should You Do When Inflation is High?

Budgets are tighter and uncertainty runs rampant in times of inflation. But there are some steps you can take to protect yourself from the effects of inflation and make it through these financially difficult times.

Make a Budget (and Stick to It)

While it’s not the most exciting task in the world, making a budget is more important now than ever. A little planning can go a long way in keeping your spending (and saving) on track. Simply follow our easy guide to budgeting to create a realistic blueprint for your finances.

  1. Determine your income.
  2. Determine your expenses.
  3. Budget for your needs.
  4. Budget for your savings and rainy day fund.
  5. Budget for your wants.
  6. Review your budget on a monthly basis to maintain.

For a more in depth guide on budgeting, you can check out our blog post here. Be sure to include a rainy day fund in your budget; experts recommend having six months worth of expenses tucked away. Rainy day funds are important, even when budgets are tight (in fact, they are even more important when money is tight because you are less likely to be able to handle a financial emergency).

Pay Off Your Debts

Now is a great time to focus on paying off any variable debt that you have, such as credit card debts and personal loans. Since these rates can change based on other benchmarks, it’s a good idea to pay them off so that you are not subjected to increased rates. Include this as an item in your budget to ensure you prioritize it.

Look into Refinancing

Higher inflation rates tend to lead to higher interest rates. Car loans are not directly affected by the fed funds rate, and the competitive nature of the car loan industry makes the interest rates more stable than rates in other industries. But chances are the rates will increase over the next few years, as we are still experiencing incredibly low rates for refinancing.  

Refinancing your car to a lower APR can save you a lot of money in the long run and help you stretch the money in your budget. How do you know if it’s worth it to refinance your car loan? Easy! If any of the following apply to you, it’s worth considering vehicle refinance.

  • If you have a higher credit score than you did when you originally got your car loan.
  • If the trending market rates are lower than they were when you originally got your car loan.
  • If you want to stretch out your loan payments over a longer period of time.
  • If you want to add or remove a cosigner from your car loan.

Vehicle refinance can free up hundreds of dollars in your monthly budget. And in the era of hyper inflation, that can make a huge difference in your day to day life. If vehicle refinance sounds like a good idea to you, contact Auto Approve to get a free quote today!

Consider Investing in Bonds

Bonds are a great investment to make in an inflated market because they are guaranteed to keep pace with inflation. Since they are fixed rate investments, they are adjusted for inflation, making them a safe investment in uncertain times. Consider an I-bond, which can be cashed out after a year, or a Treasury Inflation-Protected Securities bond (TIPS), which can be cashed out after two years.

And that’s everything you need to know about inflation.

We hope these tips will help you navigate the waters of our inflated economy. Understanding how inflation works is important because it can help you protect your money and your investments. Inflation changes how we think about our money, making it a time to hold off on riskier investments and instead prioritize budgeting, saving, and cautious investing.

Refinancing your car loan is a great way to save some of your hard earned cash. If rates have dropped since you initially took out your car loan (and they probably have), now is a great time to consider refinancing. Get in touch with one of our refinance experts at Auto Approve today to start saving today!

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