How the Government’s Response to Inflation Could Help Savers (Analysis)

By Sally Français | Nerdwallet

This article provides information for educational purposes. NerdWallet does not offer any advisory or brokerage services, nor does it recommend specific investments, including stocks, securities, or cryptocurrencies.

Inflation has been skyrocketing around the world for months and is impacting the prices of almost everything from gas to Oreos. On Wednesday, the Federal Reserve announced steps to take action.

“High inflation imposes considerable hardship, especially on those who are least able to meet the higher costs of basic necessities such as food, shelter and transportation,” the Fed chairman said on Wednesday. , Jerome Powell, in a prepared press release. “We are committed to our goal of price stability. We will use our tools both to support the economy and a strong labor market, and to prevent higher inflation from taking hold. “

The Fed this week announced interest rate hikes next year and the end of current interest rates, close to zero. Forecasts released on Wednesday show that Fed officials are forecasting up to three interest rate hikes of 0.25 percentage points in 2022.

The Fed also increased its forecast for 2021 on Wednesday, projecting an inflation rate of 5.3% this year, higher than its previous estimate of 4.2%. In addition, he raised the inflation projections for 2022 to 2.6%, from 2.2%.

Perhaps you are a saver planning for retirement. You might be a borrower, either with credit card debt or planning a major purchase, like a mortgage on a house. For savers and borrowers alike, the news should make big waves on your money. Here is what you need to know.

Inflation simply means that the value of your money goes down over time. When your grandparents remember when a soda cost a dime, it is the result of inflation.

While inflation occurs all over the world, it has hit the United States particularly hard, according to the Pew Research Center, which has looked at inflation in 46 countries. Inflation in the third quarter of 2021 was higher than during the same period in 2019 in 39 of the 46 countries.

In addition, the United States recorded an increase in inflation of 3.58 percentage points, which was the third highest increase of any country according to Pew’s analysis, behind Brazil and Turkey.

What soaring inflation and rising interest rates mean for savers

“Inflation has been further fueled by a tight labor market,” says Leah Hartman, professor of finance and economics at the Pompea College of Business at New Haven University. “We have experienced shortages in the global supply chain. The prices are crazy, and this is especially hurting low-income consumers. “

The recent surge in inflation has worried some investors. The outlook for investors is currently just above what it was in the second quarter of 2020, which was its lowest point since the pandemic. That’s according to the Gallup Investor Optimism Index, a composite of investor ratings on various aspects of the economy, personal finance, and investing. In addition, investors have not been so pessimistic since 2014.

This survey found that current investor sentiment towards inflation is now more negative than they thought about unemployment at the start of the pandemic, when unemployment hit 14.8% in April 2020. This The figure is the highest ever recorded by the Congressional Research Service since it began collecting data in 1948.

The good news is that investors are bullish on Wednesday’s announcement, as stocks closed higher that day after the Fed meeting, which isn’t always the case when the Fed suggests interest rate hikes.

“By taking a fairly aggressive stance, the Fed implicitly declared that the economy was strong enough to withstand this tightening,” said Giuseppe Moscarini, professor of economics at Yale University. “The Fed’s forecast is for a booming economy in 2022.”

A good rule of thumb for fighting inflation is to invest rather than save money in a traditional savings account. It is thanks to the magic of compound interest. Your investment strategy could be like planning for retirement with an IRA or 401 (k), or building a well-diversified portfolio of stocks in a brokerage account.

And Hartman says, even in a rising rate environment, that’s no reason to panic.

“As a consumer, don’t go out and stock up because you’re worried about gasoline or food prices going up,” Hartman says. “It just pushes them higher.”

And even if house, car, or Oreo prices go up, you might not even necessarily see price increases, depending on your lifestyle.

What soaring inflation and interest rate hikes mean for borrowers

If you have credit card debt, expect to pay more interest when the Fed raises interest rates. Typically, credit card interest rates go up and down with the federal funds rate, so you will likely owe more interest on that credit card debt when the rates go up.

As for other types of debt, like mortgage debt, it depends. Sometimes Fed rate hikes cause mortgage rates to go up, but sometimes they go down.

If you shop from home, it is true that higher interest rates can reduce your purchasing power. That said, you don’t have to panic or rush to buy because of a possible rise in interest rates. There are other factors that factor into your decision to buy a home, including the price of existing homes, your family’s needs, and your employment situation.

“Check that inflation is really hitting the part of the basket that you spend the most of your budget on,” Moscarini says. “If house prices are rising quickly, but rents aren’t rising as quickly, and you’re a young tenant with no plans to buy anytime soon, then inflation isn’t that big of a deal.

Meanwhile, says Hartman, work to reduce debt and increase savings.

“If you have credit card debt, pay it off,” says Hartman. “If this is your student loan – and maybe it is – then go for it. Target the highest interest rate burden you have and reduce that debt as quickly as possible. “

During this time, stay focused on your long term investment strategy. With this, rising rates can be good for your finances, even if inflation hasn’t.

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Sally French writes for NerdWallet. E-mail: [email protected]. Twitter: @SAFmedia.

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