By the middle of 2021, inflation was becoming a major problem.

With interest rates jumping as high as 9.1, the impact was deeply felt by millions.

Many people do not understand, however, what inflation is. Because of a lack of knowledge, many people also unnecessarily suffer more than they need to.

Below, we will discuss what inflation is, what causes and affects it, how its effects are felt long term, and finally what we can do to lessen its power.

Inflation

What Is Inflation?

Inflation occurs when the prices of goods and services increase over time. To understand this a bit better, take coffee for example.

In 1960, a pound of coffee could be bought for $0.75. In 2022, the average for a pound of coffee is $6.47. What has changed? Has coffee gotten that much better in the past 60 years or are there other factors?

Clearly, there are other effects changing the cost of all our goods.

What Causes Inflation

Inflation is a deep, macroeconomics topic. It can get really heavy, really quickly. It is hard to simply explain the reasons for inflation, but there are two main causes.

Too Much Money

When there is a lot of spendable money in the market, it causes prices to rise. This cause and effect can be seen in a simple illustration.

Imagine there are 1,000 apples for sale. If 1000 people want to buy the apples, they can each get one apple. However, if there is more money in the economy, there may now be 1200 people that want an apple.

The problem is, there are still only 1000 apples. Now, the apple producer charges more for each apple because the demand for apples has increased while the supply of apples has stayed the same.

Thus, inflation has occurred, and apple prices have risen because more people have money to spend.

Cost Push

Cost push is simply the increase of labor or materials which increases the prices of the goods and services.

This inflation cause is felt in stages, and the consumer feels the worst part.

Take for example the cost of fuel. When fuel supplies are limited due to war or health concerns then the limited amount of supply causes the price to increase.

The fuel provider charges the trucking company more for fuel. The trucking company then needs to cover their costs, so they charge the grocery store more. The grocery store then needs to cover the added expense again, so the consumer is charged a higher rate.

How Does Inflation Affect Us Long Term?

Inflation numbers shift from month to month, and while they will not be as high as they have been in 2021/2022 forever, they are always increasing expenses. Understanding what ways you are most affected by inflation long term is important so you can understand the best ways to combat it.

1. Your Buying Power Decreases

A phrase we have not used yet but is important to understand is buying power.

As inflation rises, the power your money has to buy items decreases. $1,000 before inflation will not buy you the same goods that $1,000 after inflation will.

If you have $1,000, you can buy 1,000 $1 items. However, if that item increases by 5% to $1.05 you have lost buying power. You still have $1,000 but you can only buy 952 items, or 48 items fewer.

This effect is especially true in investments. Understanding the long-term power your retirement investment accounts will provide after inflation is important.

2. Interest Rates On Loans Go Up

When inflation rises, banks are affected. As their costs go up, their margin for profit lowers. To help keep that profit high, they increase interest rates on loans including mortgage, car, business, and personal loans.

3. Businesses And Consumers Suffer A Cost Push

We have already discussed what a cost push was, but it is important to remember that rises in prices are always going to happen.

As a business owner, you must calculate the raised costs each year to remain profitable. As a consumer, we must understand that my costs will rise every year for the rest of my life.

What Can We Do To Lessen The Impact Of Inflation?

Understanding the short- and long-term effects of inflation certainly should cause people to do whatever they can do to mitigate its impact.

Thankfully, there are four main actions we can take to help curve inflation’s effect.

1. Pay Down Debts

Any outstanding debts that are incurring interest is negatively impacting you.

The sooner you can free yourself from unnecessary lost money, the sooner you can use that money the way you want to. Additionally, every extra dollar you are not paying toward interest is like giving yourself a raise.

For those concerned about having a credit card because of the debt, see our article ways a credit card can change your life.

2. Get A Raise Or A Higher Paying Job

Speaking of raises, another great way to combat inflation is to get paid more. There are essentially three ways to do this.

You can get a raise at your current job.

You can seek out a new job that would offer you a higher salary.

You can invest in yourself and get a certification or degree to enhance your marketability in the job market. This option is usually the least utilized but can lead to in the best results.

3. Spend Less

As a financial coach, I see how easy it is to overspend even with a budget. One of the best ways to fight inflation is to simply spend less.

Additionally, when you get a raise, don’t just allocate that to spending money. Find ways you can better use the money you’ve worked so hard for and where you can cut spending.

4. Invest

A final step for fighting inflation is smart investing.

Assuming an average inflation rate of 3%, smart investing is simply a return larger than 3%. Smart investments are in funds that return higher rates than inflation to build money and help your buying power. Additionally, invest for a long time. Compound interest can drastically change your life and wipe out the power of inflation.