SSEPF3 Marsh UNIT 4 INFLATION

The Benefit and loss from inflation What is inflation: Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service.

Benefit: If inflation is controlled, it leads to increase in investment and business growth. When people are afraid of further inflation and the loss of money's buying power, they will spend it today. This leads to an increase in demand for goods and services, leading to higher production, which in turn generates employment and further income.

Loss: As prices rise, the buying power or purchasing power of your income or wealth go down. Thus during inflationary times real income and real wealth go down. Money losses its value. Higher the inflation, lower the value of the dollar, and vice-versa

The real income of the fixed income earner's goes down. If you have a fixed nominal income, as prices go up, your purchasing power (or real income) goes down. Only if your earnings are indexed to inflation (as social security checks) will one be insulated from the negative effects of inflation.

Winners Fixed-rate mortgage holders. "They're going to be paying back with devalued dollars," Auto-loan holders. Auto-loan holders who bought before inflation and locked in a relatively low interest rate benefit from high inflation because they pay off a sizable debt with devalued dollars, says Nancy Lowenberg, a financial adviser with Hiawatha, Iowa-based Securian Advisors MidAmerica.Auto-loan

Investors in stocks. Stockholders get some protection from inflation because the same factors that raise the price of goods also raise the values of companies. "Theoretically, the value of equities varies directly and proportionally with inflation," Thoma says. "When you double all prices and wages, you double profits and you double the value of stocks, basically.“

Winners Small-business owners with big fixed-rate debts. As prices for products go up, small-business owners find themselves better able to manage fixed-rate debt from investments in equipment and other business necessities, Lowenberg says.small-business owners "Think about a business that's expanding and borrows money to put in state-of-the-art equipment so that it can grow," Lowenberg says. "If inflation is higher than normal, and they're getting paid more for their product because raw material prices were up and they're paying their workers more, they're paying the debt back in stable dollars.“

Winners Investors in commodities. Bankrate senior financial analyst Greg McBride says commodity prices track the inflation rate closely. Buying storable commodities such as gold can be a good hedge against inflation.

Losers The American economy. High inflation historically has hurt the American economy, McBride says. "If you look at periods of strong growth in U.S. history, the one constant has been a very modest rate of inflation over that time." In periods of high inflation, consumers' purchasing power falls and their standard of living slides with it. Also, borrowing to fund new businesses, buy homes and finance other tasks necessary for a healthy economy becomes more difficult as lenders jack up interest rates to hedge against further inflation.

Losers People living on fixed incomes, such as a retirement or pensions. For example, when the food budget covers only the cost of 2/3 of the food it used to, people have to make a choice. Less food? Give up something else? There will have to be a choice, and a trade-off.

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