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What is inflation, how is it calculated and what does it mean for your wallet?

Inflation in the United States is at a 41-year high, according to data released Wednesday from the U.S. Department of Labor.

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Price increases in the U.S. have hit a staggering 9.1% year-over-year, according to the Bureau of Labor Statistics.

Food prices helped drive the rate of inflation during the past 12 months — the biggest annual increase since November 1981. The average price of food rose 10.4% over the past year. Gas prices rose 11% in the past month, though prices have decreased in the last week.

So, what is inflation, how is it calculated and how does it affect your wallet? Here’s what we know now about the soaring inflation rates.

What is inflation?

Inflation measures how much more or less expensive certain goods and services have become over a certain period, usually a year.

Who calculates the inflation numbers?

The Bureau of Labor Statistics uses the Consumer Price Index to measure inflation.

What is the Consumer Price Index?

The CPI is obtained by comparing, over time, the cost of a fixed “basket of goods” and services purchased by consumers in the United States.

The number is arrived at by using a series of surveys provided by thousands of businesses and consumers across the country, who keep a journal of what they purchase over a certain period.

The CPI is expressed as a percentage of the difference in the cost of the basket of goods in a set period of time, usually a month or a year.

What’s in the “basket of goods?”

The basket of goods includes items that are commonly purchased by Americans, and includes housing expenses such as rent and mortgages. Housing is the largest component of the consumer basket in the U.S.

How does inflation affect your wallet?

Higher inflation means consumers can buy fewer goods with the dollars they have to spend. You can see the cost of inflation by looking at the purchasing power of the money you make.

You do this by looking at nominal wages versus real wages.

What are nominal and “real wages?”

The number of dollars you make in your job is called a nominal wage. The amount you can buy with those dollars is called a real wage.

Real wages are determined by looking at the number of nominal dollars you have and factoring in inflation.

To get that number, you divide the nominal wage by the price level, which is the level of inflation.

For example, assuming the price level is 1 and you make $20 an hour, then your real wage is 20 divided by 1, which equals 20.

So, your real wage is $20 an hour.

Let’s say that inflation is at 5%. To calculate your real wage with that example, divide your $20 an hour wage by 1.05 (the price level plus 5% inflation). That means your $20 now only buys you $19.05 in goods.

If inflation is at 9% like it is now, your $20 buys only $18.35 in goods.

The Bureau of Labor Statistics has a calculator to help you determine your real wage.

Inflation begins to pull at a person’s wallet when wages do not keep up with the rising cost of goods. While the average hourly earnings for U.S. private-sector workers rose 2.2% since December, consumer prices rose 5.4% during the same time period.

For the past year, when you factor in CPI inflation, real wages actually fell 2.7%.

The past six months of the year represents the steepest drop in buying power since 1980.

What factors contributed to the inflation numbers?

There are several factors that account for the high rate of inflation. The rising costs of housing, gas and food were among the primary contributors to the increase.

According to the BLS, energy prices rose 7.5% in June, with gas prices up 11.2% from May.

The index for all items minus food and energy rose 0.7% in June, after rising 0.6% in May and April.

“While almost all major component indexes increased over the month, the largest contributors were the indexes for shelter, used cars and trucks, medical care, motor vehicle insurance, and new vehicles,” the BLS report read.

The indexes for motor vehicle repair, apparel, household furnishings and operations and recreation also increased in June. Among the few major component indexes to decline in June were lodging away from home and airline fares.

What led to those factors?

The COVID-19 pandemic and the shutdown of business worldwide was the biggest contributor to the inflation we are seeing now.

Because of the pandemic, businesses shut down, people became unemployed and supply lines were nearly nonexistent.

In order to help those who could not go to their workplaces or who were laid off from their jobs, President Donald Trump signed into law a series of aid packages that gave money to businesses and people’s pockets via stimulus checks.

President Joe Biden continued those stimulus packages and increased spending with other packages, pumping trillions of dollars into the economy.

While the world started gearing back up as pandemic cases eased, there was a lot of money chasing goods that could not get into stores because of supply chain issues.

Too many dollars going after too few goods is the fuel for inflation.

What can be done about inflation?

The U.S. central banking system, known as the Federal Reserve or the Fed, is responsible for setting interest rates, managing the money supply and regulating financial markets.

The Fed has implemented the fastest series of interest rate hikes in the past 30 years, designed to try to slow down business and consumer spending — thus having fewer dollars o buy more goods.

In doing that, the Fed must try to balance slowing the economy with the risk of creating a recession.

The National Bureau of Economic Research, a nonprofit considered in the financial world to be the authority of recessions and expansions, says a recession is “a significant decline in economic activity” that is widespread and lasts for several months.

That usually means not only shrinking the gross domestic product — the value of goods and services produced in a country — but also job loss, declining industrial production and a drop in retail sales.

The country is considered to be in a recession when a nation’s economy experiences those declines for at least two consecutive quarters.

When will inflation go back down?

Sarah House, a senior economist at Wells Fargo, told Vox that a combination of events will have to happen before inflation significantly comes down, including the easing of supply chain constraints, tighter monetary policy and reduced consumer spending.

“It’s going to be a while before I think consumers begin to feel a lot of relief on the inflation front,” House said.

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