As a college student-or recent graduate-terms like inflation, gross domestic product and dollar value may sound like a bunch of mumbo jumbo, but, in reality, these somewhat daunting financial phrases affect you and your debt more than you might think.
What is Inflation and Inflation Rate?
Inflation is a rise in the prices of goods and services in an economy over a period of time. Inflation is a decline in the real value of money-which leads to a loss of purchasing power. When the general price level rises, each unit of currency buys fewer goods and services. Definitely something that will affect your spending.
Inflation rate is the measurement how of much inflation rises over this given period of time. Inflation rate shows the changes in prices for good and services and is also used to calculate other things, such as:
Inflation can cause adverse effects on the economy, such as uncertainty about future inflation may discourage investment and saving. High inflation can lead to shortages of goods if consumers start hoarding due to fears that prices will increase in the future.
Some inflation is a good thing, and it should happen slowly over time, according to economists. Inflation may decrease the severity of economic recessions by allowing the labor market to adjust more quickly in a downturn.
How Does Inflation Affect You and Your Debt?
There is a myth that that inflation is beneficial to consumers who are in debt because inflation devalues the dollars that are being re-paid. However, this assumes that all of the debt is at a fixed interest rate. For most mortgages and car loans, this is true, but you have any adjustable rate debt, those debt repayments will likely rise with inflation.
The real problem lies on the income side of the equation. Your income might not increase annually with the inflation rate. Debt or no debt, inflation cannot benefit you unless your income also steadily increases. It's wise to educate yourself on the rise of inflation so you know how much less your yearly income might be worth.
GDP - The Gross Domestic Product
The gross domestic product, or gross domestic product is how the United States measures the national income. It is the total value of all final goods and services produced; the dollar value of all goods and services produced within the U.S. in a given year.
One of the largest components of the GDP is consumer spending, meaning the less people purchase, the weaker the GDP is. In times of deflation, consumers tend to be wary of purchasing high ticket items because they are fearful that there will be a better deal later on. When this happens on a grand scale, it can be tricky for the economy.
Typically, consumer debt is roughly 50% of the gross domestic product. That changed in 2007, when consumer debt equaled 100% of the GDP, which hadn't happened since the Great Depression. Because the GDP relies so heavily on consumer spending, the national debt is harder to overcome when consumers are putting themselves in much further debt.
Dollar Value and Sense - How U.S. Currency Holds Up
The value of the American dollar affects the exchange rates and how strong U.S. investments are. If the dollar experiences continued weakness against foreign currencies means imported goods and services overseas cost more, and our exported goods and services go for less.
This is either a problem or an opportunity, depending on your point of view. The U.S. has a huge trade deficit; we import much more than we export. This trade deficit means we send a large amount of capital abroad, as well as jobs. Theoretically, a weaker dollar means our exports become more competitive. This could spur increased production domestically.
The value of the dollar does affect investments, however. No one knows how long the dollar will fall, so preparing an exact investment strategy is difficult.
Here are some truths to consider when investing:
- Consider investing in companies that have overseas sales operations that can take advantage of the currency valuation differences.
- Look at domestic manufacturers that may become more competitive. The falling dollar is not going to bring back the industrial economy, but it may push some profitable companies into the black again.
- If you are holding a handful of low-interest bonds, come up with a game plan that envisions rising interest rates.