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Price jumps 'have been larger than expected' — here are 3 ways inflation can affect your finances

When inflation rises, your cash doesn't go as far: You're spending more on essentials.

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As states lift lockdown restrictions and America begins to return to a pre-pandemic normal, prices are accelerating rapidly, thanks in part to inflation, or the general rise in the price of goods and services across the economy.

There are three primary measures of inflation in the U.S., and all have seen record increases lately. In May, the consumer price index rose 5% from a year earlier, its biggest gain since August 2008. That same month, producer prices jumped 6.6% year over year, the fastest increase on record. And the core personal consumption expenditures price index rose 3.4%, its biggest gain since April 1992.

The Federal Reserve has said the price bump is "transitory" or temporary.

"I will say that these effects have been larger than we expected, and they may turn out to be more persistent than we have expected," Fed Chairman Jerome Powell told a House panel earlier this month. "But the incoming data are very consistent with the view that these are factors that will wane over time, and inflation will then move down toward our goals and we'll be monitoring that carefully."

Elevated prices can still have an impact on your budget and other areas of your finances. Here are three ways inflation can affect your money.

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Prices are going up: How inflation can affect you

Video by Courtney Stith

1. Inflation can bust your budget

The most obvious form of inflation is higher prices on goods and services. When inflation goes up, your cash doesn't go as far: You're spending more on essentials.

Recent BLS data shows price increases in common groceries including produce, meat, and dairy products. It's not just groceries, either. The cost of "food away from home" is up 4% compared to May 2020.  

If you're thinking about planning to rent a new apartment and furnish it, costs have gone up too. Rent prices are up 1.8% since last year, per BLS data, and household furnishings grew 1.3% in the last month. 

However, not all prices increase at the same rate. In the May consumer price index, grocery prices rose 0.7% compared to last year, while clothing prices grew 5.6%. Airline fares are up 24.1% over the same period. 

2. Inflation can eat into your savings

The Fed aims to keep inflation around 2% a year. Even at that rate, it's a figure much higher than the current 0.06% average interest rate on a traditional savings account, according to the FDIC. In other words, even factoring in growth from compounding interest, your savings are likely losing purchasing power over time.

That's why it's important to invest as well as save. From 2001 through the end of 2020, the S&P 500 returned an annualized 7.5%. By choosing low-cost, well-diversified assets, you can take advantage of the market's returns and the power of compound interest to more than outpace inflation and build wealth. 

3. Inflation can influence your income

Employers often use the inflation rate as a benchmark to determine cost-of-living adjustments (COLAs). The Social Security administration also uses the inflation rate to make cost-of-living increases to benefits

If you don't get a yearly cost-of-living adjustment, or you receive one that's less than the pace of inflation, that could mean you'll need to find new ways to make ends meet. You could create a new budget to stretch your money or pick up another income stream to boost your income.

'Now is not the time to panic'

Although prices are on the rise, experts say to keep a level head because the current growth in prices is normal and it may be temporary. Inflation can be a sign of a healthy economy.

Temporary price spikes are typical when coming out of a recession, Greg McBride, chief financial analyst at Bankrate, told Grow. But the country reopening also plays a role: "We're seeing an even more pronounced effect now because of the pandemic's impact on consumer spending, the supply of goods, and the capacity available to provide services."

William McGuire, an associate professor of economics at the University of Washington, Tacoma, agrees that the price jumps are likely to be temporary: "Everyone expects this inflation to be moderated by the end of the year. Now is not the time to panic."

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