Inflation is among the top concerns facing many consumers today. More than 90% of Americans said inflation was a big problem facing the country, according to a poll from the Pew Research Center. As prices on consumer goods continue to increase, people are finding it more challenging to pay their monthly expenses and set some money aside for savings.
The current inflation crisis has deep roots that won't resolve overnight. However, some tools and techniques available to financial consumers can help them overcome the effects of inflation and stay afloat.
While economists may have different opinions if a recession is on the horizon for 2023, I believe all of them would agree with the adage that ‘a penny saved is a penny earned.’ Having a rainy-day fund can lessen a recession's effects should one appear on the horizon. Now, more than ever, is the time to take stock of one's finances to prepare for any pending economic storm.”
— Anthony Hua, SVP, Director of Retail Banking, Northwest Region
Fundamentally, inflation happens when the demand for goods outweighs the supply of those same goods, leading businesses to increase their prices, which ultimately puts financial pressure on consumers.
The U.S. Bureau of Labor Statistics announced in November 2022 that the Consumer Price Index had increased 7.7% in the last 12 months. There are several macroeconomic forces on both the demand and the supply side that are driving the current inflation crisis. These include:
Some responses to combat the COVID-19 pandemic caused a boom in demand for consumer goods that suppliers were ill-equipped to meet.
Job losses and business shutdowns characterized the early months of the pandemic, leading U.S. officials to increase government spending to inject capital into the flagging economy in the form of successive economic stimulus packages.
However, government officials failed to shore up suppliers with the same vigor, creating artificially inflated demand for goods that led to an overheated economy and price increases.
Local, state and national governments across the world instituted lockdowns, business closures, and stay-at-home orders to combat the spread of COVID-19, which led to a significant (but temporary) drop in demand for various consumer goods.
As the pandemic receded and governments relaxed restrictions, consumers responded with an upsurge in spending. This was especially felt in the housing and tourism markets, where consumers proceeded with vacations and home purchases that were put on hold during the worst months of the public health crisis.
Pandemic-related business restrictions coupled with international events constrained the ability of suppliers to meet surging demand and balance consumer prices.
Supply Chain Challenges
The pandemic forcefully emphasized the interconnectedness of our world, as the effects of local and regional challenges in one area were often felt halfway across the globe. Business closures in manufacturing nations like China and Vietnam caused output to take a hit, which led to a severe shortage of parts and raw materials in much of the developed world. As businesses in the West struggled to source those raw materials elsewhere, prices rose.
Geopolitical events played a part, too. In particular, Russia's invasion of Ukraine in February 2022 led to steep sanctions on one of the world’s leading exporters of petroleum. The downstream effects of those penalties not only made gas more expensive for consumers, it also made it more expensive for businesses to transport goods over long distances, leading to a price increase.
Inflation can have serious short- and long-term economic and social effects.
Inflation can be a story of the haves and the have-nots. If you are well off and own those things that rise in price due to inflation, it can shield you somewhat from the effects of a lower-valued dollar. Suppose you are on the other end of the economic spectrum. In that case, the rising prices often outpace rising wages, or savings interest rates, causing your economic status to decline even more. But in the long run, inflation, especially rapid and high inflation, can cause a loss of faith in the currency, which hurts everyone in the economy.”
— Jim Haney, EVP, Chief Lending Officer
The immediate effect of high inflation is that it reduces consumers' purchasing power. As the prices of consumer goods increase, people have to devote larger shares of their income to essential purchases (like food and energy), which leads them to reduce spending on discretionary items (like travel and entertainment).
Moreover, the typical official response to inflation is to increase interest rates to lessen consumer demand and relieve suppliers. This makes it more expensive for consumers to finance large purchases such as home or auto or pay for education. Rising interest rate also affects businesses due to higher borrowing cost of capital, which can lead to slower expansion or growth. The desired effects of increasing interest rate is to slow down economic activities and reduce inflation.
Economists have observed an inverse relationship between unemployment and moderate levels of inflation, a phenomenon known as the “Phillips Curve,” a theory that claims “rising prices for consumer goods are generally good for businesses, even when they are initially unable to meet demand.”
The effect tends to be temporary, however. It takes time for consumers to change their spending habits in response to inflation, but as high prices continue to put pressure on cash-strapped families and individuals, they stop making certain purchases. This behavior change usually takes a hit on businesses that eventually respond to a decline in demand by laying off workers.
Inflation tends to be more severe for middle- and lower-income families and individuals, which can worsen economic inequality and exacerbate the social problems that result from it.
Higher-income individuals often have the financial resources and flexibility to weather a crisis, according to the Brookings Institution, a public policy think tank. Not only do they usually have more stable and reliable incomes, but they also have more assets to collateralize and use to offset the financial pressure.
The result is that higher-income individuals are able to stay financially afloat when inflation rises, while middle- and lower-income consumers are disproportionately exposed to financial insecurity and loss. This might even cause long-term damage to their socioeconomic standing.
The National Bureau of Economic Research defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” In addition to successive periods of declining gross domestic product (GDP) — or the standard economic growth rate, a commonly cited sign of a recession — economists also consider indicators like unemployment, consumer spending, and income changes when determining the applicability of the term “recession” to an economic downturn.
Inflation does not necessarily lead to a recession, but it is one of the signs that a recession is on the horizon. After a prolonged period of high consumer prices — coupled with the increasing cost of obtaining capital from lending institutions — individuals tend to reduce spending and focus more on finding cost-saving opportunities.
The resulting drop in demand forces businesses to scale back their own operations, leading to a constriction in economic growth that can cause unemployment to rise, eventually resulting in an even greater financial pinch on consumers, especially those who lost their jobs.
As news reports of business closures and job losses proliferate, economic anxiety takes hold, leading to further drops in demand and even slower economic activity.
Economists disagree over whether the current inflation crisis will lead to a recession. According to a survey by the National Association for Business Economics, just over half of economists believe the United States has a more-than-even chance of entering a recession in the next 12 months.
There are still steps officials can take to stave off a recession. The Federal Reserve Bank, for example, is implementing an aggressive monetary policy, raising interest rates in the hopes of achieving a “soft landing” and avoiding a complete economic crisis.
Inflation and talks of recession can be scary for consumers. Here are some of the steps you can take to stay ahead:
Put money in a high-yield savings account: A high-interest rate is bad for spenders but good for savers. Consider opening a high-yield savings account to take advantage of higher interest rates. These accounts can earn significantly more than standard savings accounts, with returns that tend to increase in high-rate environments.
Pay down your debts: Making as many debt repayments as possible could help you avoid the worst effects of inflation. Certain debt holdings, like credit cards, have variable interest rates, meaning the amount you pay in interest could go up with the higher rate. Paying down those debts can help you avoid costly interest payments later.
Keep a monthly budget: Rising prices for consumer goods can make it hard to pay your monthly expenses, especially for essentials like food and energy. Take full stock of your monthly expenses and make adjustments based on your expected cash flow to keep you from becoming overwhelmed by rising costs.
The cost of living is still high, but the inflation rate seems to have peaked. If the inflation rate is still much higher than the Fed’s target of 2%, there is a long way to go. While the rise in prices of goods and services continues, the more painful part for consumers is that we don’t know exactly how long it will last or how we should react financially. Many clients have put their cash in high-yield money markets or CD accounts.”
— Jack Sun, SVP, Director of Retail Banking, Southwest Region
Whether the current inflation crisis will lead to a recession or not, surging prices will continue to negatively impact financial consumers for the foreseeable future. Continuing supply chain challenges, rising interest rates, and disruptive international events will all likely constrain suppliers’ ability to meet high consumer demand and keep prices elevated.
Fortunately, there are proactive steps financial consumers can take to stay ahead of these challenges and stay financially afloat despite the rising costs of living. In addition to the planning mentioned above and budgeting measures, Cathay Bank offers a variety of products and services that you can leverage to navigate through economic uncertainty with poise and success. Contact us for more information.
This article does not constitute legal, accounting or other professional advice. Although the information contained herein is intended to be accurate, Cathay Bank does not assume liability for loss or damage due to reliance on such information.