Consequences of High Inflation

For the past two years, inflation has appeared to be right around the corner. The inflation rate for the first decade of this century was mild and the US economy hasn’t seen anything close to extreme inflation since the early 1980’s. Still, with the government printing money at a pace many thought was not possible, inflation is one of the consequences that most people expect. Typically, financial planners recommend that when considering your financial future, you factor in an inflation rate of somewhere between two and four percent. The inflation that could come to the economy as a result of the massive government spending and bailout programs recently could make a 4% rate of inflation seem mild.
It’s impossible to predict when inflation is likely to show itself in the economy but most agree that it’s coming. If it’s as extreme as many are predicting, we could be in for some tough times ahead. Here are some of the likely consequences of high inflation.

Savers Suffer: If you’ve done a good job of saving money, you’re probably counting on those savings to be worth something to you when you need them. Cash sitting in the bank is safe and liquid but in an inflationary environment, it can lose value quickly. For example, if your savings or money market account pays an interest rate of one percent (a rate that we would love to see right now!) but inflation is growing at a rate of four percent, then your money has three percent less spending power every year. This is part of the reason that financial advisors recommend an asset allocation that is a mix of stocks, bonds, and other investments that have a chance of outpacing inflation over time. There is risk in these asset classes, but inflation can put the value of your cash at risk as well.

Wage Increases Create Illusions: One of the common factors that often accompanies higher prices of goods and services is higher wages for workers. However, the increase in wage rates rarely keeps up with the pace of inflation. Still, a raise of six or seven percent seems like a great deal and can often cause people to become less disciplined in their spending. Inflation rates that are higher than wage increases can make it difficult to stick to the type of budget you’re accustomed to. These changes don’t typically happen overnight, especially in a developed economy like the one in the United States, but it can come more quickly than people can adjust to it in some cases.

Difficulty for Businesses: Inflation can create an uncertain business planning environment. A good business plan takes into account the cost of goods and services associated with running a business. If inflation moves higher quickly, it can be difficult for companies to manage production, inventory, and distribution of the goods they provide. In addition, the way to combat inflation from a macroeconomic level is to raise interest rates which will increase the cost of capital for businesses that are dependent on outside financing to grow.