Finally, after over a year of pandemic life, things are starting to return to normal. As we get back to our normal lives and normal spending habits, most experts predict that the economy will continue to grow at an increasing pace. With markets near all time highs already, a potential economic boom risks overheating the economy and therefore has us on inflation watch.
Over the coming months, there will likely be many headlines about inflation that add to the noise. We hope this blog article cuts through the noise and provides some education and context around the inflation conversation.
What Is Inflation?
According to Investopedia, inflation is “the decline of purchasing power of a given currency over time.”1 In other words, inflation represents the rising costs of goods and services. The government tracks inflation by monitoring the Consumer Price Index or CPI. The CPI represents a basket of goods and services within the economy and tracks the change in prices over time. According to InflationData.com, the average inflation rate since 1913 has been 3.1%. Back in the 70s and 80s, inflation was consistently over 5%, but in the last 10 years inflation has averaged under 2% per year.2
Why Does Inflation Matter?
Keeping track of inflation is important for several reasons. First, it is an important indicator of how the Federal Reserve will adjust interest rates. Typically, the Federal reserve strives to keep inflation around 2% or less. However, a rise of inflation indicates an overheated economy. To slow the economy back down and control inflation, the Federal reserve may increase interest rates. An increase in interest rates typically affects bond prices negatively and makes borrowing more expensive.
Inflation is especially important to monitor for those that rely on a fixed income. This mostly applies to retirees living on Social Security or a pension like CalPERS or CalSTRS. While most pensions have some sort of Cost of Living Adjustment (COLA) built in, not all do. Even those that do, often have a maximum COLA like Social Security (2.6%). If inflation rises drastically, your fixed income might not keep up with the rising costs of goods and services.
Why Are We Talking About Inflation Now?
Inflation has not been an issue in over a decade. While a bit of inflation is to be expected as our economy gets going, recent indicators have shown that inflation may be coming quicker than we anticipated. Last month, April 2021, the CPI grew by .8%. This was the largest monthly increase in over a decade and if that pace were to continue for 12 months, that would come to 9.6%. This would be more inflation than we’ve seen since the 80’s. While only one month of data, this rapid increase has sparked conversation around inflation among investors and financial professionals.
So, Is Inflation Back?
While indicators are starting to point to the return of inflation, there is a chance that the unique challenges of recovering from a pandemic are contributing to some of these numbers.
One personal example I’ve seen involves my favorite baseball team, the Los Angeles Dodgers. This year, the prices of tickets have skyrocketed from their 2019 levels. At a glance, one might attribute that to inflation. However, if we look closer, we can see that it is just a unique situation related to the pandemic. Because of state restrictions, the Dodgers are only selling 25% of the tickets they usually sell. This low supply combined with increasing demand causes an artificially high ticket price.
Another example is in the used car industry. In April of 2021, the used car industry grew by a staggering 10%! According to Bloomberg, “with fewer new cars being made amid a shortage in critical semiconductors, both retail consumers and rental car companies have gone to the used-vehicle market to get the wheels they need.”3
It is very possible that situations like these have added to the inflation numbers but are actually just temporary symptoms of our choppy pandemic recovery.
Our Team’s Takeaways
- Pay attention to inflation, but do not panic.
- Be prepared for inflation, whether it comes or not. You can do this by making sure that any money you have dedicated to the future is in a position to keep up with or outpace inflation.
- Talk to your financial advisor. Next time you review, bring up inflation and see if your financial plan is set up to withstand the risk of inflation. If you need an advisor, schedule a time to meet virtually with a member of our team!
Stay Well,
Alex
1 https://www.investopedia.com/terms/i/inflation.asp
2 https://inflationdata.com/Inflation/Inflation_Rate/Long_Term_Inflation.asp
3 https://www.bloomberg.com/news/articles/2021-05-12/record-surge-in-used-car-prices-is-key-culprit-in-inflation-jump