Federal Reserve and Inflation
The Federal Reserve and inflation are something that everyone is dealing with, from the gas pump to food prices at the supermarket. Of course, if you’re a retiree on a fixed income, your major concern right now is ensuring that you have enough money to pay for your everyday needs.
We’re going to discuss a lot of key issues in this article and how you should think about these topics rather than listen to the doom and gloom you’ll hear in the media.
What are We Talking About When We Say Inflation?
Inflation is occurring across the world right now, and when we say “inflation,” it’s best to look at some of the bigger items that are being affected right now. However, before we provide a few examples, it’s important to know why inflation is happening right now.
Unfortunately, the pandemic is the main driving factor of inflation. For example:
- Stores and shops closed down
- Material shortages began
A snowball effect happened with these two points, and then government spending increased, causing what is now an inflationary period in our economy. Many areas of your daily life are experiencing inflation and rising costs, but some of the most noticeable include:
- Transportation: Car prices are high, primarily due to high demand and a low supply.
- Fuel: Gas and heating costs are rising due to inflation and what’s happening in Ukraine.
- Grocery: Food prices have risen drastically in the past year due in part to supply chain issues and rising food costs.
- Housing: Almost across the board, housing prices are much higher than they were a year ago, even in areas far outside of major cities. Low mortgage rates, the tight housing market and other factors impacted the housing market. Even rental prices are going up, sometimes significantly.
With all this in mind, the Federal Reserve is working to bring inflation back down to modest levels.
Understanding the Federal Reserve’s Approach to Inflation
The Federal Reserve has been adjusting interest rates to help fight inflation, but what does this really mean? When you raise interest rates on money that people will borrow, you restrict buying opportunities.
For example, if a person is looking for a new car, they’re far more confident with their purchase when it’s at a low rate. However, raising interest rates slows demand because customers aren’t going to be confident with their purchases.
Since supply is low, the lower purchases will allow inventories to build back up and leads to:
- Lower prices
- Lower profits for businesses
If we go back to the pandemic, there was too little supply and demand for cars. Car dealerships raised the prices of some cars by $10,000 – $15,000, and the increase in price was all profit. Many vehicles remained on the lot from before the pandemic hit and even used car prices skyrocketed.
Since people still needed cars and bought them, there was no incentive for dealerships to lower prices back to normal rates.
Even with buying a house, if you look across the country, people were paying higher than the listing price and bidding wars occurred. With higher interest rates, maybe buyers will pay the asking price or below on a home and bring the market down to more affordable prices.
The Federal Reserve is in a difficult position because they need to:
- Pull back on inflation
- Experience a soft “landing,” where the economy is still growing
Sometimes, rising interest rates will cause a major recession, but the Fed is trying to hit the “soft” landing mark to make the impact less dramatic.
How Retirees Can Adjust to Inflation
Retirees have a little more control than a non-retiree because they are less susceptible to inflation. In most cases, these individuals:
- Already have a home
- Already have a vehicle
You can choose to stay out of the market until inflation and the risk of a recession passes. If you want to travel, you may want to travel when pricing comes back down. Retirees have more flexibility than someone who is working and tied to a family. You can wait for slow seasons and better travel prices compared to someone who has kids and needs to travel during busy seasons.
Food is one of the areas of inflation that will still impact a retiree.
You may need to eat out less often or change your diet to save some money. Unfortunately, food prices are hitting everyone hard.
When we develop a financial retirement plan for our clients, we account for inflation in the plan. Since we account for inflation, people are impacted less than someone who is just playing the market.
Inflation isn’t a new thing, and in the 70s, the Fed raised interest rates to help tame inflation. However, the Fed raised and cut rates over and over again without a clear direction. The end result was 10 years of inflation during the 70s that went from 5% to 12%+ inflation before it came back down and then hit 12.5% in 1980.
A lot of our listeners know that in the 70s, inflation was all over the place.
The Fed doesn’t want to make the same mistake. In the last 100 years, inflation has had an average rate of 3%, which is what the Fed is trying to target. We definitely won’t have 6% inflation for the next 30 years.
We’re in a period where there’s a bump in the financial landscape, but we will get through this period.
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