Over the past few years, the United States has suffered levels of inflation not seen in decades.
Since the start of 2020, inflation spiked by over 20%, and the cost of living has swelled as a result, according to the U.S. Bureau of Labor Statistics. However, inflation has cooled immensely from its highs in 2022.
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But that doesn’t mean that inflation has gone down. Worse yet, it means the value of the money you have saved is at risk.
To understand exactly why that is, it’s important to break down what inflation means.
UNDERSTANDING INFLATION
Inflation occurs when money loses its value, causing prices to rise across the board.
To understand inflation, it’s important to understand supply and demand.
To keep it simple: when there are fewer people demanding a good or service, the price for that good/service falls. The same is true of supply; when there is less of a good or service, the price rises.
The graph below demonstrates how this works.
While many economists quibble over what exactly qualifies as inflation, the consensus is that inflation goes up as more money enters the economy.
After all, when the supply of currency increases, the “price” (i.e. value) decreases.
HOW INFLATION WORSENED
Thanks to lockdowns amid the COVID-19 pandemic, many people were forced to stay at home. During this time, the federal government spent trillions through the Cares Act and other spending bills to keep the economy afloat.
When lockdowns were finally lifted and people were allowed to go back outside, consumer spending skyrocketed. Thanks to the lockdowns, many businesses were still unable to accommodate this massive flux in demand (meaning there was less supply), causing prices to soar, as well.
“When we came to our senses and started opening the economy back up, there was just — not just for gasoline and oil but for a variety of goods and services — just an explosion of demand,” UCF economist Sean Snaith told News 6.
With so much more money in circulation and so many supply shocks slowing production, it resulted in a huge swell of inflation, reaching 9.1% in June 2022. Those sorts of figures hadn’t been seen in roughly 40 years.
While inflation in 2024 has still been above target levels, it has slowed down immensely. As of September 2024, the year-over-year rate was 2.4%, BLS data shows.
INFLATION IS COOLING
While the rate of inflation has cooled by a huge factor since 2020, overall inflation is still up. And it’s still growing.
Of course, that’s all by design.
The Federal Reserve aims to keep the rate of inflation at around 2%. The primary means that the Federal Reserve says it uses to achieves this are manipulating interest rates and increasing the money supply.
- INTEREST RATES: When the Federal Reserve lowers interest rates, it makes the cost of borrowing money cheaper. This can encourage more people to take out loans, which means that more money is being spent within the economy. Conversely, when inflation becomes too much to handle, the Federal Reserve may increase rates to discourage borrowing.
- MORE MONEY: The Federal Reserve doesn’t simply print cash to add to the economy. Instead, it can essentially create money out of thin air. To do so, it engages in “quantitative easing” — creating new bank reserves on its balance sheet to buy up assets like Treasury securities (which help fund the federal government) and corporate debt.
WHY DOES THE FEDERAL RESERVE WANT MORE INFLATION?
According to the Federal Reserve itself, the whole idea behind keeping inflation up — that is, more spending — is that it helps motivate production.
The logic goes that when people are spending their money on goods and services, it motivates sellers to ramp up production on these goods and services to better meet market demand, thus growing the economy.
As a result, government spending, quantitative easing and rising interest rates can be used to stimulate economic growth.
However, the main problems that critics point to are twofold:
- REDUCED SPENDING POWER: As more fiat currency (i.e. money like the U.S. dollar that is backed solely by faith in the government) is added to the economy, the value of that currency goes down. That means you have to spend more money to acquire the same amount of goods that you could before — hence, inflation.
- MALINVESTMENT: If the government and Federal Reserve put more money into the wrong types of projects (those with low market demand), that money could end up being wasted, ultimately becoming a drain on the resources used to make that investment.
“The government shouldn’t be picking winners and losers in the economy,” Snaith explained. “Throughout history, governments are notoriously bad at making those decisions, and that’s why markets are the most efficient way we have on this planet to allocate resources.”
THE TRADE-OFF
On the other hand, reducing inflation would require deflation, meaning that people are spending less money, which further means that sellers are producing fewer goods/services.
“That trade-off is sort of highlight between inflation and the unemployment rate,” Snaith explained. “If you want to bring inflation down, the unemployment rate needs to rise, and vice-versa.”
This process helps to bring down price levels, though it could involve recessions or — if bad enough — depressions, which is why the Federal Reserve seeks to avoid it. Proponents of quantitative easing argue that this is a critical role upheld by the bank.
But can the Federal Reserve keep economic growth going indefinitely?
THE ANSWER IS: PROBABLY NOT
The Federal Reserve doesn’t have a perfect track record for controlling economic growth.
“The central bank is not omniscient,” Snaith told News 6. “Obviously, they’ve got a legion of economists trying to predict the economy. But anybody that’s in the prediction business knows that mistakes and predictions about anything are part of the process.”
For example, to help pay for the war effort during World War I, federal monetary policy sparked massive inflation — around 80% over a four-year window — which ended with a harsh depression starting in 1920.
Poor credit management by the Federal Reserve during the 1920s was blamed for the infamous Great Depression of the 1930s, which was debatably worsened by the New Deal spending program under then-President Franklin Roosevelt.
During the World War II era, the Federal Reserve again brought interest rates low and ratcheted up inflation to help the federal government finance the war. This was followed by another serious recession after the war was over.
Inflation again ramped up between 1965 and 1982, but this time, it was accompanied by high unemployment — a phenomenon known as “stagflation.” Of course, another recession soon followed.
The Federal Reserve’s monetary policies were even linked to the “dot-com bubble” in the 1990s, as well as the 2008 economic downturn.
Again, this goes back to the issue of malinvestment. When money is continually invested in projects or business ventures that people aren’t demanding, then people won’t (voluntarily) spend their money on these goods/services.
This means that production becomes unprofitable and is eventually forced to drop, which could pave the way for another recession.
HOW DOES THIS IMPACT MY SAVINGS?
All of the inflation that’s happened so far isn’t going away. It’s now baked into the price tags you see during a trip to the grocery store.
But even worse than that, it’s chipping away at your savings.
As you might have picked up on by this point, as inflation rises, it means that the value of money goes down. Thanks to this, the money you’ve saved is losing its value over time as inflation continues to increase.
For example: if inflation stays consistent at 2% per year, then $100,000 now will be worth just under $60,000 by 2050. And only around $40,000 by 2070, when many young people today would otherwise be able to plan for retirement.
WHAT CAN I DO ABOUT THIS?
An effective way to circumvent this sort of issue is by investing money into financial or physical assets — things like real estate, stocks, precious metals, high-value savings accounts, or other types of securities — to better hedge against inflation.
“This is why things like gold become more popular when there’s inflation,” Snaith explained. “Because it’s a real asset whose value will rise in a way to offset any effects of inflation.”
Regardless, Snaith assures that when left to their own devices, markets will eventually correct themselves.
“But how long is that going to take, right?” he said.
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