Understanding Inflation: How Rising Costs Impact Your Budget

Inflation can be sneaky. Here's how it could be hitting your wallet.

If you've been following the news, you've probably heard that a wave of inflation is making life more expensive. But what exactly does that mean?

Inflation refers to a rise in the cost of goods and services. Or, to put it another way, during periods of inflation, you'll need to spend more money -- sometimes, a lot more -- to buy the things you normally purchase.

Some degree of inflation is normal over time. In 2020, for example, the inflation rate was 1.4%, according to Consumer Price Index data published by the Labor Department's Bureau of Labor Statistics. That means goods and services cost 1.4% more on average than they did the previous year.

But in May, the cost of goods and services rose 5% compared to price levels from a year prior. And that's a more drastic jump.

Why is inflation hitting us so hard right now?

The U.S. economy is in the process of staging its recovery after a brutal 2020 and rocky start to 2021. That's certainly a good thing. But a rise in consumer demand has caused a supply crunch, which is driving up the cost of goods and services.

Let's also remember that many supply chains were disrupted during the coronavirus pandemic, when factories and plants were shut down and workers were furloughed. Now, manufacturers are operating in catch-up mode, but they're not doing it quickly enough. And when the demand for pretty much any item or commodity exceeds its supply, prices are apt to rise.

That's precisely what's happening in the housing market today. Limited inventory is driving home prices up at a time when prospective buyers are eager to capitalize on low mortgage rates. And the same concept applies to much less expensive purchases, like the everyday items you might buy at the grocery store.

What's costing Americans more?

Well, pretty much everything. These days, you might end up spending more money on things like:

• Gasoline
• Supermarket purchases
• Restaurant meals
• Clothing
• Home improvement and maintenance

What's more, if you're looking to buy a car this summer, prepare to be shocked. Granted, an automobile is far from an everyday purchase, but it's also an essential one if your vehicle stops running.

How to combat inflation

The tricky thing about inflation is that it can sneak up on you. You may not notice you're spending an extra $3 a week at the pump or $12 a week at the supermarket. But in time, that additional spending could add up and cause you to have to rack up a credit card balance.

The best way to avoid that is to be mindful of your spending. You can't avoid buying food altogether, but if you notice your grocery bills are higher than usual, you may need to cut back temporarily in a different category, like entertainment.

If you charge a lot of your living expenses on your credit cards, a good bet is to check your balance every week rather than wait for when your bill comes due. That way, you'll be clued in to what you're spending.

Will prices stay high for long?

It's hard to say. As supply chains catch up to demand, prices should begin to decline. But whether that happens this summer, this fall, or all the way into 2022 is yet to be determined. That's why it's important to be vigilant about your spending -- and to keep close tabs on your finances on a regular basis.