How to Beat Inflation

 How to Beat Inflation. 

This may   seem strange at first, because if inflation is  defined as an increase in the general level of   prices in an economy over time, then measuring  it would seem to be as simple as keeping track   of the prices. However, this is not always  the case, as inflation can take many forms.   The substitution problem is one of the biggest  issues plaguing modern inflation measurements   because when we measure inflation, what we’re  really interested in is how the declining   purchasing power of currency is likely to impact  our future expenses, 

“Get a better idea”

So we can get a better idea   of how much money we’ll need to save up for  a new car 10 years from now or how much of a   savings account we’ll need for a vacation. It is  common knowledge that the consumer price index   (also known as the cpi) measures inflation  by looking at the prices of more than 90,000   different goods and services. However, most of us  will never be able to afford all of those items,   so the cpi’s stated annual inflation rate may  not feel accurate to the average consumer.

 Although, the cpi is the most widely used of  the inflation metrics we’ll be looking at today,   it’s not without debate. Consumer price indexes  (CPI) used to measure inflation by comparing   the change in the price of a fixed basket of  goods and services over time; for example,   if a carton of eggs cost $2 last year and  $2.05 today, inflation would equal to 5%   for the eggs; the government performed this  comparison for numerous goods and services   and assigned weights based on how  important they were perceived to be.

 These values differ quite wildly from the  values assigned to them in the early days of   cpi they also periodically change the products  or services that are being compared to better   reflect consumer behavior some examples include  temporarily dropping things like refrigerators   and new car sales from the list during the  world war ii era when production of those   items was temporarily banned and finally they  also adjust the actual price changes observed. 

In the early 1930s, food and clothing made up  about half of the weight of the cpi’s equation due   to the fact that they consumed roughly the same  amount of people’s budget at the time, but that is   not always true today, and that may cause a fixed  basket fixed weight approach to be ineffective in   many cases. The personal consumption expenditures  price index, or pce, is the second measure of   inflation we’ll look at today. It is calculated  by the Bureau of Economic Analysis and shows   the prices businesses are actually selling items  for, 

Rather than the prices consumers are paying   for them, as the cpi shows. On the surface,  this may seem like exactly the same thing,   because if I buy a bag of carrots for two dollars  at the local supermarket, then doesn’t that   mean t In some cases, a consumer’s price for an  item and the price a business is charging for an   item are the same, but in other cases, the price a  consumer pays for an item and the price a business   is charging for an item are different, such as  in the case of medical costs, where a co-pay is   often required for visits to the doctor’s office. 

The cpi would not reflect this discrepancy but the   pce would. because it looks at what the business  in this case the doctor is actually charging   instead of just what the consumer is paying out  of pocket on the bright side this may give us   a better idea of how costs are changing over  time since it takes into account more factors   which is probably why the fed considers the core  pce which is just the pce excluding volatile food   and energy categories to be its main measure  of inflation when attempting to maintain its   two percent per year target though 

It  does take other metrics into account on the other hand it may be less relevant to  ordinary consumers both because its focus is   less on what people are paying and more on what  things actually cost and the fact that just like   with the cpi it may not actually reflect any  individual consumers purchasing behavior the   third measure of inflation we’ll look at today is  the gdp deflator this is a less well-known measure   and it goes about things a little bit differently  than the previous two instead of looking at a   basket of goods and services it calculates the  change in prices from one period to the next across the entire economy 

It does this  by dividing nominal gdp by real gdp and   then multiplying by 100 to convert to  a percentage gdp as many of you know   is simply a measure of the total monetary value of  all goods and services sold in a country excluding   exports over a specific period of time its  value changes due to one of two factors   either the price of the goods and services in  an economy change from one period to the next   

Or the amount of products and  services sold in an economy changes so if you wanted to determine how much prices  have changed you simply need to isolate that   factor from the number of goods and services that  are sold in a given period economists do this by   recalculating the total monetary value of sales  in the current period using prices from a prior   period so in other words by multiplying the  sales volume of the us in 2021 by 2020 prices   

And comparing it to the current year’s actual  gdp you can work backwards and solve for the   price inflation experienced that year on the one  hand the gdp deflator is very useful because it   compares the entire economy against itself from a  previous period Aside from monitoring changes in   prices, it can also record changes in consumer  spending habits, which solve the substitution   problem that afflicted the early CPI. This implies  that it can be a fairly accurate indicator of how   inflation affects individuals on an economy-wide  basis.

 For most people, the gdp deflator is more   difficult to calculate and understand than a  few hundred or thousand goods and services,   because you need to keep track of all of them  and not just their prices, but their sales   volume as well. Additionally, since the gdp  deflator is focused on an economy-wide scope,   it doesn’t do as well at helping us to understand  the changing costs of any individual pr. 

  Today, we’ll take a look at the quantity  theory of money as a gauge of inflation. Instead of trying to predict an inflation  rate, quantity theory of money focuses on how   the amount of money in circulation influences  the price of goods. A simple example is shown   in the following equation. The amount of money  in circulation divided by the velocity of money   equals the price of the products sold When  the money printers are running and the supply   of money is doubled but people are cooped  up and not spending as they normally would   because the velocity of money is slowed, prices  will not necessarily double. The same could be   said if companies were more productive. 

It is  also important to consider the velocity of money,   or how many times each dollar changes hands in a  certain period of time, and then how many products   or services are sold. It’s impossible to use  the theory to predict your financial future   since we don’t know when and in what amounts  money will be created or taken from circulation,   nor do we know how those other variables of the  equation will play out during those periods.

   The relative worth of other currencies and types  of money, such as commodities and precious metals,   is the sixth indicator of inflation we’ll examine  today. Some argue that because commodities and   precious metals are likely to be among the first  parts of the economy whose prices are influenced   by inflation, we should instead use metrics like  the cpi and the pce, which are considered lagging   indicators. One disadvantage of this strategy  is that the price of commodities in precious   metals might fluctuate for a variety of causes,  not all of which are related to an increase in   prices throughout the whole economy. 

It would be  more difficult to plan out your personal finances   if inflation directly affected the pricing  of commodities and precious metals,   which would make it even more difficult  to see where prices are moving the most. A currency’s relative value to other currencies  is another popular method for gauging inflation,   but there are many reasons why a currency  may appreciate or depreciate relative to   other currencies that are not related  to inflation in the broader economy   and it doesn’t really tell you what inflation  is like in the home country’s currency. 

  for instance a country that regularly imports  more than it exports can see the value of its   currency decline over time and this can  be a contributing factor to inflation just look at Lebanon though it’s rarely the only  factor at play and at least over the extremely   long term there is some evidence that commodity  prices reflect inflation it’s just that they have   some notable drawbacks when trying to capture an  isolated inflation rate especially in the here. 

And now the sixth and final measurement that  we’ll look at today is budgetary inflation   put simply this is just the amount your spending  increases from one year to another on the plus   side this approach is the only method that is  tailored to your specific financial situation   on downside your data point of one and  people’s lives and spending habits tend   to change in different phases of their life think  of the different things that you spend money on   when you have kids for instance.

So when used in isolation   this approach does very little to help you plan  out your finances long term because you have no   frame of reference for how these lifestyle  changes will affect your future spending so those are six common measures of inflation none  of them do a perfect job of allowing you to see   how changing prices could affect you both now and  down the road 

But thankfully when viewed together   you can give yourself a better idea of what’s  going on in the here and now as well as what   may be coming down the road for you personally  for instance you could combine your own personal   spending history with historical inflation rates  measured by the cpi for specific categories that   you have spent little or no money on before such 

 As child care or medical costs as you age in order   to get a better idea of what your costs might  look like when the time comes for you to start   spending money in those areas without sacrificing  the personalized aspects that can really only be   measured by looking at your own financial history. 

Leave a Reply

Your email address will not be published. Required fields are marked *