The effects of inflation on budgeting

What is inflation?

In the simplest terms, inflation is when prices increase over time. Typically expressed as a percentage, inflation represents the decrease in purchasing power over time. The inflation rate in the US is calculated by analyzing the price increase of consumer goods and weighing each price based on how important they are to the average consumer.
In June 2022 inflation in the US peaked at 9.1%, the highest rate since 1981, meaning that consumer goods cost 9.1% more than the previous 12-month period.

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Whether you’re well-versed in economics or not, you likely have first-hand experience with the price increase in your everyday purchases, like groceries, gas, or clothing. Higher prices due to inflation require creative budgeting and new strategies to stretch your income. While inflation can be unpredictable, there are simple steps you can take to protect yourself from financial strain.

How inflation affects your money

Inflation affects your day-to-day budgeting as you account for higher costs on necessities, but it can also impact your savings and debt. If your savings accounts earn less than the rate of inflation, the money you save will be worth less in the future than when you initially deposited it.

For example, if you put away $500 into a savings account that earns 1% in interest, you’ll have $505 after one year. However, if inflation is 9%, you’ll have less buying power than when you started. To keep up with inflation, you would have to earn enough interest to have $545 after the year. High-yield savings accounts might be a better option for short-term savings, as they typically have higher returns than traditional accounts.

If you’ve noticed higher credit card bills due to inflation, it might not just be because of higher prices at the grocery store. To try to bring down prices, the Federal Reserve raises its interest rate, and credit card issuers usually pass these higher rates on to consumers by raising the annual percentage rates (APRs). This additional interest on your credit card balances can make a big impact on your budgeting. To save on interest, try to pay off your credit card balance each month, or consider transferring your debt to a card with a 0% APR promotion to save on interest during times of high inflation.

How to update your budget for inflation

Even small price increases can overwhelm your perfectly planned monthly budget. Rising grocery and gas costs make even necessary purchases challenging. To account for higher prices during inflation, try these budgeting tips to reduce your spending and prepare for the future.

1. Cut out unnecessary costs

Unless you’re willing to look for a higher-paying job, you’ll likely need to cut costs when budgeting for inflation. Start by identifying any unnecessary spending in your budget and decide what you’re willing to cut out. If you don’t want to ditch your entire entertainment budget, swap expensive experiences for more budget-friendly options. For example, cross out the international vacation and pencil in a more affordable road trip in your home state, or choose Netflix over pricey movie theater tickets.

2. Adjust your grocery list

Unfortunately, your budget might be tight even after cutting out unnecessary spending. Grocery costs often feel the largest impact of inflation, making even your basic needs difficult to budget for. Make small changes to your grocery list to try and save money over time. Pick generic products over brand-name and plan your meals around sales and coupons. If you’re able to buy in bulk when there’s a great deal, you’ll be able to make your money stretch in the long run.

3. Add to your emergency fund

If you don’t already have an emergency fund, prioritize starting one ASAP. But even if you’ve saved enough for three to six months of expenses, you’ll want to reconsider your savings due to inflation. Re-evaluate how much your expenses have increased due to inflation and make sure your emergency fund matches up. Whether you get laid off from your job or need to pay off an unexpected bill, you’ll be grateful for the extra breathing room during times of higher interest.

Even with unexpected increases in inflation, there’s plenty you can do to cut costs and make room in your budget for your daily needs. By carefully planning your savings and monthly budget, you’ll be prepared for even the worst economic circumstances.