How Much Should You Worry About Inflation?

Last week, the Labor Department put out two important inflation measures: the Producer Price Index (PPI) and the Consumer Price Index (CPI). The PPI, which tracks the average change over time in the selling prices received by domestic producers, rose 1.6% in February. The CPI, which came out two days later and tracks how much consumers pay for goods and services, was up .5% in February.

Of course, I don't have to tell you that inflation bells are ringing. You've seen the jump in prices at the grocery store, and, maybe more significantly, at the gas pump.

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"The question for consumers right now is: Is this a permanent change that is signaling that inflation is about to take off -- or a temporary increase? Should you read the data as a blip driven by the Middle East, or is it a sign that we're about to hit an inflationary era?" asks Mark Thoma, a professor of Economics at the University of Oregon and author of the blog Economist's View.

His take? We're not on the verge of a massive inflationary episode, but as the economy recovers, there's a good chance that food and other commodity prices will stay high.

Here's what you need to know about inflation:

Supply and Demand
We talked about this recently, but one reason food prices will likely stay on the higher end is because of basic economics: Lower output plus increased demand equals high prices. "We're seeing higher world prices for food and other commodities, and that's not something that the Fed can do anything about. When there aren't enough tickets to the concert, prices go up," explains Thoma. "We're not on the verge of a great big Fed-induced inflation, but I do think that we're likely to see a higher cost of living."

Labor Is Steady
Luckily, raw materials only account for about 30% of the cost of an item. Labor, on the other hand, is 70 to 80%, according to Thoma. That means increased energy prices may not bleed through into other areas of your budget -- in fact, excluding food and energy, the consumer price index rose only .2% in February, and apparel actually declined .9%. Right now, wages are relatively steady -- if we start seeing them take off, other prices are likely to follow, and that's when inflation might start to have a bigger impact. With the current job market, this isn't yet an issue -- and it may not be for quite a while.

Interest Rates Should Remain Low

Thoma says he doesn't expect the Fed to change interest rates, at least through the end of the year, unless inflation really does start suddenly taking off. Of course, this news has a mixed impact: If you're living on interest income -- as many people in retirement are -- you want rates to go up. If you're living on variable interest rates -- credit card debt, or an adjustable rate mortgage -- an interest rate increase would kick you when you're down.

Plan Ahead
Your best protection against rising prices -- whether they're at the pump, the grocery store, or the mall -- is to plan for them. That means squirreling away money, so you have an emergency fund, and keeping some fat in your budget so a higher grocery bill won't throw your whole month off.

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