How Worried Should I Be About Soaring Inflation?

(Bloomberg Opinion) -- A couple of weeks ago, I tried to order a chai latte at one of my favorite Upper West Side coffee shops. “Oh no, we ran out of our chai yesterday ... you know, supply-chain issues,” the barista told me.

Supply-chain problems became the almighty boogeyman in 2021 alongside Covid, and now its partner in crime, inflation, is the thing causing anxiety. The Consumer Price Index rose to 7% in December 2021, which is the highest it's been since the early '80s. But should the typical consumer be worried about inflation? Although it's not worth panicking, it is wise to understand how your budget might change.

Inflation is a normal occurrence in which the price of goods and services goes up and the purchasing power of money goes down — your dollar won't buy as much today as it did a decade or even a year ago. Inflation is the reason it's critical to invest instead of storing your money under a mattress. Leaving all your money in cash means it essentially loses value to inflation every year. This is bread-and-butter personal finance stuff.

But anxiety may be starker for those of us who have never experienced significant inflation but remember a recession. A prevailing concern, other than not being able to get our chai lattes, is that higher prices are here to hang out for a while — due to both supply-chain issues and labor shortages increasing costs for companies that are then passed on to consumers.

Sustained inflation can lead to a rise in interest rates, which could make it financially difficult for some to buy a home or car. Alternatively, it could mean that some people are currently buying at the top of a bubble in frenzied markets such as housing and used cars.

It is critical for those who planning to buy a home soon to evaluate if their prospective new house is overvalued. It's also important to keep emotions in check in a competitive marketplace and not take on a mortgage that is too burdensome in terms of monthly payments, especially if you'll be paying more for other goods. The fear is ending upside down on your mortgage and finding that you owe more than the home is worth in the future.

But more than an increase in overall prices and interest rates, what should really worry us is if inflation triggers a recession. Low inflation has sometimes been a precursor to recessions in the past. It's hard to use history as a road map here because the circumstances that can cause inflation and a recession vary wildly. But one question to ask is: What will the Federal Reserve do to minimize the impact of high inflation and prevent a potential recession?

In the late 1970s, the Fed started to raise interest rates to quickly quell inflation, though this ultimately led to the 1981-1982 recession. The interest rates of today were slashed in 2020 because of the pandemic, but the Fed is signaling a raise in rates coming soon. Unemployment rates of the early '80s peaked around 11%, though, considerably higher than where we are now at 3.9%, which the Fed has indicated makes it more comfortable with raising rates.

The whisper of a recession triggers millennials into worrying that the stock market is going to collapse and that investing is therefore a fool's errand. It's not, but one should brace to see losses on the page. After experiencing the longest bull run in the modern market, this won't be easy.

Focus on examining what you need to withstand a potential recession. Is your portfolio balanced in a way that feels aligned with your current investing goals? Should you perhaps talk to a certified financial planner for a tune-up? Maybe you don't even check your portfolio if we enter a sustained market correction so that you aren't tempted to panic-sell.

This aim here isn't to dog-whistle or cause undue alarm. The economy is cyclical. There are booms and contractions. The measured move is to consider how to adjust your personal finances to deal with inflation or a potential recession. The cost of necessary goods will likely continue to rise for a period of time, which means trying to fit a larger grocery bill and transportation costs into your current budget. This may mean trimming the fat in your budget or shifting to lower-cost products for a while.

One of my favorite techniques to feel some semblance of control and tamp down anxiety is creating a bare-essentials budget. This way I know the bare minimum my household needs per month to meet needs such as housing, transportation, food, utilities, insurance payments and so on. This number also informs how I build my emergency fund. It provides peace of mind in a moment of perceived or real crisis. For me, it was a useful tool early in the pandemic when my income took a massive hit for several months. My husband and I were able to immediately switch over to the bare-essentials budget for a while to minimize drawing down on savings.

Money, anxiety and potential panic over the unknown will make all of us act irrationally in some ways. After dealing with two years of a global pandemic, it's exhausting to think we may have to sustain yet another debacle — but being proactive and taking measured steps to shore up household finances now could help offset some of the fear.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Erin Lowry is the author of “Broke Millennial,” “Broke Millennial Takes On Investing” and “Broke Millennial Talks Money: Stories, Scripts and Advice to Navigate Awkward Financial Conversations.”