Economy 101: When will inflation go down?

Does it seem like everything is getting more expensive? Well, that’s because everything is getting more expensive. Inflation — the rate at which prices increase — has been very high for the last few years, and it’s affecting prices on everything from utility bills to grocery runs.

High inflation is squeezing budgets across the country. But when will inflation go down? Let’s find out. 

What is inflation, and how does it work?

Inflation is an increase in prices for goods and services. It’s measured as a percentage rate that refers to the annual increase in prices. It’s measured in retrospect, so it measures the annual rate from the past year (the previous 12 months).

For example, say that one year ago, the price of a movie ticket was $10. Today, that same ticket costs $11. This would imply a 10% inflation rate.

So after one year, that same thing (a movie ticket) costs 10% (or $1) more than it did. And if inflation were to hold steady at 10%, that same ticket would then cost $12.10 the following year.

Inflation can affect prices for all goods and services. Groceries, energy prices, housing, restaurant meals, haircuts — you name it. And while prices may change at different rates, in general, inflation tends to push prices up economy-wide.

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For instance, gas prices may increase 20% in a year, while the price of a gallon of milk only increases 5%. Both scenarios indicate inflation, but the prices are changing at a different rate. Economists usually take an average of sorts (explained below) to measure how much inflation is affecting prices throughout the economy.

One thing to note is that inflation is normal. In fact, the government wants inflation, to some extent, as it’s a normal part of a healthy economy. Most governments have inflation targets in the range of 3%-3% per year. Here in the U.S., the Federal Reserve targets an inflation rate of 3%. 

Where inflation gets problematic is when it gets higher than these target ranges. Last year in 2022, for instance, inflation was consistently over 7% and as high as 9.2% at its peak.

How is inflation measured?

There are several ways that inflation is measured by economists and governments. In the U.S., one of the main metrics is the Consumer Price Index, or CPI. You may have seen this term in inflation news stories, as it’s one of the primary measurements that is quoted by the media.

The CPI is calculated based on a “basket of consumer goods and services” that is designed to represent typical household spending. It tracks prices across categories including housing, food, energy, commodities, health care, and more.

Essentially, the CPI is an average of the price increases going on across the economy. And it’s a key metric that the Federal Reserve and Congress use to monitor and respond to inflation.

Why is inflation high right now?

Inflation has been abnormally high since around the spring of 2021. During that time frame, the CPI has ranged from 4.3% all the way up to 9.2%. In April 2023, the CPI was 4.9% (the lowest figure in two years).

Inflation has been high for a variety of reasons. Pandemic-fueled shortages and supply chain issues have led to rising prices, while the war between Russia and Ukraine has led to soaring energy costs. And a tight labor market has led employers to offer higher wages, which also tends to push up prices.

During the period of high inflation, there were a few unique drivers of inflation in the U.S. economy. Used cars, for instance, soared in value, pushing up the CPI. Food prices, and particularly some staple foods like eggs, also skyrocketed in price.

High inflation strains wallets across the country, so the government responded by raising interest rates. Higher interest rates lead to a slowdown in borrowing and spending, which often helps to lower inflation. (However, it can also lead to soaring mortgage rates). The Federal Reserve, led by Fed chair Jerome Powell, has used interest rate increases as a key component of monetary policy to fight inflation.

When will inflation go down?

How long will inflation last at this high rate? We don’t know for certain, but fortunately, it already appears to be going down somewhat.

According to data from Statista, inflation rates have been on the rise since summer 2020, with a rapid increase starting in spring 2021. Rates peaked in spring/summer 2022 and have been slowly declining ever since.

It’s unclear whether this trend will continue. However, the Federal Reserve is continually raising interest rates, which should help to continually calm inflation.

Inflation going down vs. deflation

There’s a common misconception about inflation. Basically, “inflation going down” doesn’t mean that prices will go down. It simply means that prices will increase less quickly.

Remember, inflation is measured as year-over-year change in prices. So 4% inflation means that prices have increased 4% in the last 12 months. If inflation then goes down to 3%, prices will grow at a slower rate — but they will still be increasing.

The opposite of inflation is “deflation.” This is when prices actually decrease over time. Deflation is very rare in modern economies and can cause significant economic problems of its own.

For the U.S. economy, most economists agree that inflation of 3%-3% per year is healthy.

How to strengthen your finances against inflation

Inflation may not remain high forever, but it’s still wise to prepare your finances for the possibility. Here’s what to focus on.

Earn interest on your savings

Inflation essentially reduces the buying power of money. One dollar in a year from now will buy less goods and services than it would today. To combat this, it’s a good idea to keep any savings in accounts that earn interest — or to invest in the stock market or other growth assets.

A high-yield savings account is a good idea, as they tend to pay more than standard savings accounts.

If you have kids, check out Greenlight. Greenlight is a savings and money app for kids and teens that offers up to 5% rewards on Savings*, plus the opportunity to invest for the future.

Pay off debt

Inflation tends to lead to interest rate hikes, which in turn increases the APRs on debt products (like loans and credit cards). When APRs increase, it becomes more expensive to borrow money and to pay off existing debt.

If you can take steps to pay down debt and avoid taking on additional debt, you’ll pay less in interest.

Make a budget

Building and using a budget is an important personal finance task that can help you be more aware of your spending, which in turn can help you save money. A good place to start is by tracking your spending for a month, then adding up the totals in each category. From there, you can build a budget from scratch or use a budgeting app to help.

Inflation is already going down, but it’s still affecting the economy

As of spring 2023, the inflation rate appears to be on a downward trend — but it’s still relatively high, at around 5%. While that’s much better than the 9.2% peak in 2022, 5% is still substantial. It’s wise to prepare your finances for periods of high inflation.

Now is a great time to learn more about money management, budgeting, investing, and more. The better your understanding on personal finance topics, the smarter choices you’ll make — and the more prepared you will be for inflation. The Greenlight Blog is a great place to level up your money knowledge — with all kinds of personal finance topics for parents and their kids. 

Greenlight tip: if you do have kids and teens, the Greenlight app is a powerful tool for teaching financial literacy concepts.

Ready to learn about the world of money? Sign up for Greenlight today! 

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