From increased prices at the grocery store to rising rent costs, chances are that you’re experiencing the impacts of inflation on the economy in many different aspects of your life. Understanding the many effects of inflation on the economy can help you to make sense of these rising prices and anticipate what other changes you might see.
Inflation refers to the rate at which the price of goods and services increase over a period of time. Inflation is caused by an increase in demand for a product, and/or a decrease in the supply of a product. As demand increases or a product becomes scarcer, the product’s price rises.
Inflation isn’t always negative. In fact, the Federal Reserve tries to maintain an ongoing 2% inflation level. When inflation is too low, interest rates fall, and that can prompt an economic downturn. A 2% inflation level helps to keep the economy functioning well without straining consumers too much.
But inflation rates that are too high negatively affect the economy, too. The US Inflation Calculator tracks inflation over time. According to the calculator data, in 2020, inflation was at 1.4%, but as the pandemic resulted in manufacturing and shipping shortages, inflation climbed to 7% in 2021. Rates dropped slightly to 6.5% in 2022, and in 2023, we’re still feeling the effects of that higher-than-average inflation, with rates at 3.2%.
What are the effects of inflation on the economy? Changing inflation rates impact more than you might think.
When inflation is high, the price of nearly everything increases, including necessities like food, gas, and electricity. Maintaining the same standard of living costs more, and those on a fixed income may have to cut back on spending.
Those higher prices have an impact on planning for retirement, too. The money you planned to live on each month doesn’t go as far when inflation is high, meaning you will need to save more to comfortably retire.
Inflation also has a significant impact on healthcare costs, including healthcare staffing costs and medication costs. A West Health survey conducted in June of 2022, when inflation reached 9.1%, found that higher healthcare prices strained many American budgets. The survey revealed that approximately 38% of American adults had to delay or skip treatment, borrow money to pay medical bills, or cut back on driving, utilities, and food to pay for their healthcare during the first half of 2022.
Those higher healthcare costs result in higher health insurance premiums, too. Health insurance providers must charge higher rates to make up for their own increasing prices. According to the Kaiser Family Foundation, premiums for family health insurance coverage increased by 20% over the past five years.
One of the positive effects of inflation on the economy relates to your mortgage payments. Let’s say you have a fixed monthly mortgage payment of $1,200 for a 30-year term. As inflation occurs during the life of your mortgage, you’ll continue paying that $1,200 per month, but the value of your mortgage payments decreases. Essentially, after 10 or 20 years of inflation, you’re paying less in value for your mortgage than you were when you first bought your home.
You won’t see those benefits with a variable-interest mortgage. Instead, your mortgage payments will increase to keep up with inflation.
Higher inflation tends to correlate with higher interest rates, too. The Federal Reserve uses interest rates to help regulate inflation that is too high. By driving up interest rates, the Federal Reserve discourages consumers from making larger, riskier purchases, like financing a new car or applying for a mortgage to buy a home. As inflation rates decrease, the Federal Reserve gradually lowers interest rates in response.
Inflation and unemployment are closely linked. As inflation rises, unemployment tends to drop. In contrast, when unemployment rates are high, consumers tend to cut back on spending. With more people looking for jobs, employers don’t need to increase staff pay to attract employees. In turn, employers don’t have to raise prices to cover those higher wage costs, and prices stay steady, decreasing inflation rates.
It can be difficult to withstand the effects of inflation, especially when it’s impacting your living costs. If you haven’t done so already, consider creating a budget to help you make sure you have enough money set aside for essentials each month. If you’re planning to buy a home, carefully consider mortgage interest rates to make sure that you’re timing your purchase well. You may want to revisit your health insurance plan, especially during open enrollment, and look for a plan that gives you the coverage you need within your budget.
Inflation has widespread economic effects, but those impacts aren’t all negative. Keep in mind that inflation fluctuates, so while inflation rates are high right now, with time, they’ll decrease again.
Paige Cerulli Paige Cerulli is a freelance content writer and journalist who specializes in personal finance topics. She graduated from Westfield State University and brings more than a decade of professional writing experience to the ConsumerCoverage team. Paige’s work has appeared in outlets including USA Today, Business Insider, and more.