iQuanti: If there’s anything we’ll remember about 2022, it’s unfortunately the fact that inflation spiraled out of control. Consumers saw the price of nearly everything increase, and inflation is currently at a 40-year high.
While inflation is typically considered to be a bad thing, did you know there might actually be an upside to rising prices? In this article, we’ll explain what that is and how it could work to your benefit.
How does inflation work?
Simply put, inflation is when the price of goods and services rises. This normally happens at a modest rate of approximately 2 to 4 percent per year. But when there’s a major disruption in the economic forces of supply and demand like we recently experienced with the COVID pandemic, it can upset the balance between them.
The most widely used indicator of inflation is the Consumer Price Index or CPI. The CPI is defined as the average change in the price of consumer goods and services paid by consumers such as food, energy, and rent.
When the U.S. Bureau of Labor and Statistics (BLS) releases its latest inflation report, what they’re sharing is the 12-month change in the CPI. In other words, it’s the average of how much the price of the things we need has increased over the year.
How can inflation benefit borrowers?
While most people will see the cost increases as a negative thing, it cold actually have some positive impacts on consumers with fixed debt. For instance, suppose you have a 30-year fixed-rate mortgage that costs $1,000 per month. If inflation for that year was 4 percent, then next year that $1,000 will “feel” like $960. Why? Because all your other bills will most likely have gone up by the rate of inflation. At the same time, however, you may have gotten a raise at work to keep up with the rate of inflation, frequently referred to as a “cost-of-living-adjustment.” Either way, even though you’re still paying the same exact $1,000, it now only has $960 of relative purchasing power because $40 was effectively destroyed by inflation. Now continue this trend 18 years into the future. You’ll still be making that same $1,000 payment. However, by this point, it will effectively be like paying $500 in today’s money. Essentially, half of your payment has been erased by inflation.
The bottom line
Inflation is defined as the 12-month change in the CPI or the price of a typical basket of goods and services. While cost increases are generally regarded negatively, borrowers may find some relief through the steady decline in the effective cost of any fixed debt.