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How to Help Protect Yourself Against Inflation

Reading time: 4 minutes

Highlights:

  • Inflation is the gradual increase in the cost of goods and services over time.
  • It’s critical to review your budget more frequently during periods of high inflation than you would otherwise.
  • Your savings are an important buffer against rising costs, so make sure you’re continually setting money aside for an emergency.

Inflation can put a significant strain on your budget and wallet. In order to protect your financial situation during periods of high inflation, you’ll first have to understand what inflation is and how it works.

What is inflation?

Inflation is the gradual increase in the cost of goods and services over time. Practically, it means that your money may not be able to buy as much today as it could in the past.

Periods of high inflation may result from a variety of factors.

Sometimes a period of sudden economic growth can cause increased inflation. If consumers start spending more money than usual, businesses may find themselves selling more goods and services than they anticipated. As a result, these businesses may find themselves unable to meet the increased consumer demand, so their remaining stock becomes more valuable and prices go up accordingly.

Other times, inflation can be the result of factors outside of the economy. Inadequate production of oil and natural gas, for example, may cause inflation. Natural disasters or major world events can disrupt supply chains and reduce the amount of goods available, driving up prices on the stock that remains. It’s also possible for a combination of these factors to occur simultaneously or for one to occur as the result of another.

Inflation is measured using price indexes, which record how prices change over time. The Consumer Price Index (CPI) is the most common of these. It monitors price changes for a set of 80,000 goods and services that American consumers buy regularly.

It’s important to remember that inflation is not the same as the price increase of an individual good or service. So, if you notice the cost of a dozen eggs has gone up by 10 cents over the past month, that’s not necessarily inflation. It could instead be due to short-term labor shortages, supply chain challenges or increased demand, and the price might return to its previous level over time.

But if you notice the cost of a dozen eggs, gas, a new car and your hotel room are going up simultaneously, it’s likely that inflation rates are rising.

How does inflation affect interest rates?

Interest rates tend to go up during periods of high inflation.

The Federal Reserve — also known as the Fed — uses interest rates as an important tool to manage U.S. economic activity. When inflation is high, the Fed is likely to raise interest rates, making it more expensive and more difficult for people to borrow money. Increases in the cost of borrowing money can help to slow down consumer and business spending, allowing supply chains to catch up to the production of goods and services, which can in turn lead to a drop in prices.

On the other hand, when the economy is slow, the Fed may decrease interest rates, making it easier for people and businesses to borrow money. Lower interest rates may help to stimulate the economy by reducing prices and encouraging growth.

Changes to interest rates due to high inflation typically happen on a delay. So, there may be several months between when inflation occurs and the Fed adjusts interest rates.

What can I do to beat inflation?

Inflation may sound scary, but with the right tools in your financial toolbox, there’s no need to fear. Consider these strategies during periods of high inflation:

  • How to budget during inflation
    It’s critical to review your budget more frequently during periods of high inflation than you would otherwise. Take time to update your budget to reduce unnecessary spending and find extra money for essentials. For example, you may be able to switch to a cheaper internet plan, cancel some subscription services or curb online shopping.
  • How to spend during inflation
    Flexibility becomes key during periods of high inflation. If the name brands of your favorite groceries are too expensive, try the store brand instead and seek out the best deals by comparison shopping. Also aim to avoid major expenses such as a new car, a big wedding or expensive home renovations. When possible, it’s best to make do with what you have until inflation eases and prices drop.
  • How to save during inflation
    Your savings are an important buffer against rising costs, so make sure you’re continually setting money aside for an emergency whenever you're able. Also, look for opportunities to take full advantage of the rising interest rates that generally accompany high inflation. For example, consider opening a high-yield savings account, which has a better rate of return than a typical savings account.
  • How to invest during inflation
    If you’re already investing, you can generally continue with your current strategy, especially when it comes to retirement accounts. However, diversifying your investments can allow you to spread risk more evenly across your financial portfolio. For example, if the value of a high-risk stock you own takes a plunge, you’ll have more stable investments, like bonds, to absorb some of the blow.

The good news is that in most cases, inflation is temporary, and prices are likely to decrease over time. Until then, you can use these strategies and a little of your own financial ingenuity to weather the storm.

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