Inflation occurs when you have an increase in prices for goods and services. Prices for items you need may rise at a slow rate so it is hardly noticeable. At other times, dramatic increases known as hyperinflation can raise prices to significantly high levels that create noticeable changes in your cost of living. Rising prices and high unemployment with little growth in the economy cause stagflation.
All these situations affect the standard of living to a certain degree, and not in a good way.
Inflation leads to a reduction in your purchasing power and damage to your investments, both of which can affect your lifestyle and standard of living.
Loss of Purchasing Power
Inflation lessens the purchasing power of your money. A product you purchased for a dollar 20 years ago would cost a lot more today. Inflation is easy to see over a long period of time, but it can put a dent in your purchasing power whenever it goes up.
If inflation rises 5 percent for the year, you will need 5 percent more in income to match what you purchased last year. Even if you get a 3-percent raise, you still won’t be able to buy what you bought last year for the same price if there is 5-percent inflation. Essentially, you will be paying out more of your income because you haven’t earned enough to keep up with inflation. This can significantly affect your lifestyle if inflation continues for a long period of time.
Damage to Your Investments
Inflation also has an effect on your investments. If you have money invested at a 5-percent interest rate and inflation rises at the same rate, you haven’t made anything. You won’t earn as much as you wanted even if inflation rises 2 or 3 percent. If inflation goes to 6 or 7 percent, you have actually lost on your investment.
Factors of Inflation
Debates continue on what defines inflation. The Consumer Price Index, commonly called CPI, considers rising prices and living costs as inflation. Other factors contributing to inflation may include rising prices in fixed-income securities, land and short-term interest rates, as well as growth in debt, interest and living costs compared with income.
Various factors boost inflation at different times and may affect the standard of living for certain segments or large portions of the population, depending on which items have inflated prices and costs.
Different Goods and Services
Certain products that have rising costs are not included in the CPI, which has changed its measure of inflation over the years to reflect the changes in what people buy. Not everyone buys the same goods, however. While the CPI may indicate a low inflation rate on consumer goods overall, you may personally experience more inflation than your neighbors. This can happen because the prices of the specific items you buy might rise for some reason, which can affect your costs and standard of living.
Not all items experience the exact same rate of inflation. For instance, during one economic period, gas, energy, coffee and cotton prices rose dramatically higher than the average CPI inflation rate during the same time.