By now we are all keenly aware of the word “inflation” and what it means. News stories about skyrocketing egg prices, staggering home prices, and increased car prices have been dominating the news for a year or more. We tend to address this term as something that is evil, but do we actually understand how it works?
Inflation isn’t some giant hammer blow that comes down and instantly makes everything we do or buy more expensive. It doesn’t work that way. If it did, it would be much easier to see and predict and thus, stop or slow down.
Inflation is event-driven. It happens in parts of the economy, then ripples out to affect bigger and bigger areas. It is most damaging to us as consumers when it hits goods and services that take a large part of our budgets already.
Think of your income as a pie chart. It’s a full circle. Your spending or saving will eat up that entire pie. Housing may take up ¼ of it. Energy costs may take up 1/10th. Groceries may account for 1/15th. Vehicle expenses may occupy 1/10th. Retirement saving may take 1/10th. That continues on until the entire pie is occupied and all your income is accounted for.
If you spent $3 per week on eggs, and the price of eggs doubled, then your expenditure on eggs would go to $6. Yeah, that’s an inconvenience. You’ll complain about how the price of eggs shot up, but it won’t really change your life. Your pie chart percentage of groceries won’t move in any significant way.
Now let’s talk about housing. You rent a nice apartment from a good company, and that apartment cost you $750 per month. The day your lease renews your rent doubles. Now it’s $1,500 per month. Same apartment but due to a housing shortage, the going rate for a nice apartment has increased across your entire area. Just like the price of eggs, your housing cost has doubled. Instead of taking ¼ of your
income, it takes 1/3rd. That’s a huge shock to your financial pie chart. Unlike eggs, which you could just refuse to buy, you have to live somewhere. The new cost of your housing will make you re-define other parts of your pie chart in order to accommodate the bigger slice that housing occupies.
Then your car finally gives up the ghost and you need to buy a new one. Your old car payment was $300 for a decent reliable car, and that wasn’t a huge deal. Now, for a similar car, you’re going to have to pay $600. Your choices are severely restricted. Either buy an older, less reliable car, or just figure out a way to account for an extra $300 per month going toward vehicle expenses.
In many ways, this is what has been so damaging to our spending in this latest round of high inflation. Two of the biggest pieces of our budget pie chart (Statistics, 2021) (housing and cars) have seen some serious inflation (Louis, 2023) . Housing prices have skyrocketed as inventories remain at historic lows, and the 2-year slowdown of vehicle production has left a shortage of late model cars on the market, which has driven prices into the stratosphere (Cargurus, 2023). Higher interest rates have only compounded the issue (pun intended for your finance folks out there).
Luckily, we have a very strong labor market still (U.S. Bureau of Labor Statistics, 2023) and consumers had more money saved up from Covid stimulus and from NOT spending much money for the better part of 2 years. Employee wages on average have climbed a bit (U.S. Bureau of Labor Statistics, 2023), but not enough to offset the entire effect of this round of increased inflation.
The coming year or two may force many people to make decisions they won’t like. People might have to stay in their home instead of buying a new house. Vacations might have to be skipped. Discretionary spending in general could have to be curtailed. Overall, there has been quite a bit of pain felt by consumers’ wallets, and that pain will continue to make itself known for some time. Some people will HAVE to buy cars and homes regardless of the steep prices and high interest rates.
Is there relief in sight, or is this the new normal? Should you hunker down and drive your old car and stay in your same house until prices go back down? Home price increases are some of the stickiest parts of inflation. Once they go up, they rarely go back down. Car prices have moderated some, but they may not revert to pre-pandemic prices.
You and me and all our fellow consumers need to prepare for this to be more-or-less the new normal. Housing prices are going to eat up a larger portion of our financial pie than they used to. Auto prices might likely do the same.
Evaluate your budget and spend carefully. If you have to purchase a home, accept higher rent, or buy a new car, have realistic expectations of what you can afford. Things like annual vacations may have to be skipped or reduced. Interest rates and prices are going to stay elevated for quite some time in all likelihood. Be smart and be careful.
As always, you can find this and many other articles pertaining to personal finance and financial planning at our website: www.paducahfinancialconsultants.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.