MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

YOU DECIDE: Why fear inflation?

By Dr. Mike Walden
North Carolina Cooperative Extension Service

There's no doubt about it, the inflation numbers are up. Over the past year, the inflation rate is running at over 4 percent, compared to under 3 percent for the previous year. Even stripping out volatile food and energy prices, the trend has been toward faster rising prices. Much of the recent jitters on Wall Street has been due to concerns about what the government — specifically the Federal Reserve — will do to keep inflation in check.

So why is there all this fear about inflation? What is it, if anything, that makes inflation so bad for the economy? Is inflation ever good, or is it good for certain kinds of people and businesses?

Let's begin with the bad parts of inflation first. From an individual perspective, the biggest problem with faster rising prices is the possibility your income won't rise at the same pace. If inflation is running at 4 percent and you get a 4 percent pay raise, then you've not fallen behind. The issue, of course, is whether you will get the 4 percent pay hike. Furthermore, the higher inflation is, the more of a pay raise people have to receive just to tread water.

Over time economists do see increases in wages, salaries and other compensation keeping pace with inflation, and in most cases, actually exceeding it. However, there's no guarantee this is true for everyone and every occupation. Also, there appears to be a lag, or catch-up period, to the process in that it may take a couple of years for employers to incorporate the new, higher inflation rate into their decisions. In the meantime, workers can suffer.

Yet inflation isn't a cakewalk for businesses either. It's fair to say that competition among businesses has increased enormously in recent years. The Internet, faster communication and increased foreign trade have all increased buying options for consumers. So when a business cost increases, business operators will think twice about passing that cost on to consumers out of fear buyers will simply take their purchases to a competitor.

Most businesses, therefore, agonize over raising prices. Usually when faced with a cost increase like higher fuel prices, a firm's first approach is to look for ways to economize and become more efficient. Although these efforts can pay off, they're not fun. So the bottom line is, higher inflation isn't a picnic for businesses either.

The financial markets are impacted by inflation in a big way. When the inflation rate moves up, so, too, do interest rates. This makes borrowing more expensive, and sales of big-ticket items like homes, vehicles and appliances usually suffer.

People with adjustable interest rate loans are particularly adversely affected by higher inflation. The rise in interest rates that accompanies higher inflation will push up monthly loan payments. If the borrower hasn't planned for these increases, or if the borrower's income hasn't also increased, then the higher loan payments can be a real problem. In fact, after the recent rise in both inflation and interest rates, bankruptcies on home loans jumped.

So does anyone or anything benefit from higher inflation? Actually, there are some potential winners. Among the winners are borrowers who have loans with a fixed interest rate and fixed payments. As inflation increases and eventually pushes up wages and salaries, these loans take a smaller part of borrowers' budgets and so become relatively cheaper.

Historically, some investments have also benefited from higher inflation, among them real estate, precious metals, commodities and collectibles. Investors who have money in these categories can make more money when the inflation rate is higher.

Balancing these pros and cons on higher inflation, there appear to be more negatives than positives, and most economists would agree. But, as always, you decide!

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Dr. Mike Walden is a William Neal Reynolds Professor and extension
economist in the Department of Agricultural and Resource Economics of North
Carolina State University's College of Agriculture and Life Sciences. He
teaches and writes on personal finance, economic outlook and public policy.
His You Decide column is provided every two weeks by the Department of
Communication Services. Earlier You Decide columns are available on the Web
at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm
Related audio files are at
http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html