Is Inflation Good Or Bad? (2024)

Prices are rising from the grocery store to the gas station. According to the consumer price index (CPI), the chief measure of inflation in the U.S., prices increased 8.5% over the prior 12 months in July.

While higher prices make it more challenging for Americans to afford everyday essentials, inflation isn’t always necessarily bad. In some cases, inflation can be a good thing for the economy.

The Impact of Inflation

Inflation is the word that economists use to describe the gradual rise in prices throughout an economy.

In the U.S., economists use indexes like the CPI, which measures the change in prices paid by consumers for housing, food and fuel, or the personal consumption expenditures price index (PCE) to measure how much prices change over time.

When inflation rises, dollars are worth less than they were in the past. As a result, people have less purchasing power and need to increase their incomes to maintain the standard of living they’re used to.

Let’s say your take-home pay was $5,000 in July 2012. To maintain your standard of living in 2022, you’d have to earn $6,352 today. (For more calculations like this one, check out our inflation calculator to see how much inflation impacts your income.)

Inflation vs. Deflation

While inflation may decrease the purchasing power of your dollars over time, economists generally believe that a low, steady level of inflation is necessary to drive economic growth.

How can inflation be a good thing? One way to look at this question is to consider the opposite of inflation: Gradual price decreases across the economy are known as deflation.

When an economy experiences deflation, the prices of goods and services fall and the value of money grows. As a result, consumers can purchase more items and services with the same amount of money as before

Sounds great, right? The trouble is that some negative repercussions come with deflation.

Deflation signals falling demand for goods and services and increasing supply, which drives prices lower. This may indicate that consumers are pessimistic about the economy, spending less money, and holding on to their cash.

Over time, deflation undercuts the production of goods and services, leading to layoffs and increasing unemployment. Some economists think that deflation is even more dangerous than inflation.

When Is Inflation a Good Thing?

Can inflation be a good thing? Surprisingly, yes. Some level of inflation is crucial for the economy.

The Federal Reserve has two jobs: maximize employment and maintain price stability. The Federal Open Market Committee (FOMC) judges that an inflation rate of 2% helps achieve those mandates.

This amount of inflation allows households and businesses to make financially sound decisions on saving, investing and borrowing money.

The Fed is tasked with keeping inflation at a healthy level by adjusting the nation’s money supply and interest rates. When the economy is expanding too quickly and inflation rises, the Fed will typically raise interest rates or sell assets to reduce the amount of cash in circulation. This makes it more expensive for people to borrow money, which slows economic growth and reduces inflation.

While high inflation can be harmful, too little inflation can also weaken the economy. When the economy is struggling and inflation is too low, the Fed will take the opposite approach by lowering interest rates or buying assets to increase cash circulation. The goal is to make it easier for people to borrow money and spur economic activity.

Who Benefits from Inflation?

A steady, modest level of inflation is beneficial for the economy, and it can also benefit regular consumers—the following three scenarios outline who benefits from inflation.

Homeowners Benefit from Inflation

When inflation reduces the purchasing power of money, people pay more for housing, and that means inflation increases the value of property.

Inflation also increases the cost of land, material and labor for building new homes. That curbs new construction and makes existing homes more valuable, boosting demand and further benefiting home prices.

People with Fixed-Rate Debt Benefit from Inflation

If you have fixed-rate debt, like a mortgage or a student loan, inflation helps you.

Federal student loans carry a fixed interest rate of 4.99% for undergraduates—that’s less than the current rate of inflation. When the rate of inflation exceeds the interest rate on student loans, the cost of borrowing money to pay for college decreases.

If you have a fixed-rate mortgage with an interest rate that’s less than the rate of inflation, your debt is decreasing in value. As noted above, inflation is also increasing the value of your home.

The average interest rate for a 30-year fixed-rate mortgage fell as low as 2.8% in 2021—well below the current inflation rate. As inflation and prices rise, your mortgage is worth less, helping to improve your finances.

Investors May Benefit from Inflation

Investors can benefit from inflation, but it’s important to understand that some stock market sectors benefit more than others.

Broadly speaking, companies that can raise prices for their goods and services in line with inflation will benefit, while those with inelastic pricing will suffer. For instance, energy stocks typically benefit from the rising price of oil, while people continue buying the basics despite inflation, aiding consumer staples stocks.

How to Protect Your Money from Inflation

When inflation is rising at a rate higher than normal, here are steps you can take to protect the purchasing power of your dollars.

• Trim your expenses. To minimize the impact of inflation, review your spending and identify areas to reduce or eliminate completely. It will free up money to invest so you can be better prepared for the future.
• Wait to pay off low-interest debt. Paying off debt is usually good, but you may want to hold off on making extra payments if you have low-interest debt. Your debt becomes less expensive due to inflation. The extra money may be better used for other purposes—like paying off higher-interest loans.
• Invest your money. Inflation causes your savings to be worth less over time. To hedge against inflation, you need to invest your money in the stock market. If the prospect of investing is scary, consider a diversified portfolio of index funds to lower your risk levels.