Navigating Inflation: Smart Strategies for Better Choices | Diving In

How do you make better choices when inflation starts to
buy it? Inflation, you see, doesn't just raise prices. It
also makes it harder to figure out what your best
choices are. It tricks people into staring at the bigger
dollar number instead of asking what those dollars can actually buy.
It blurs the signal. Was that one price jump you
just saw about something real? Or is the whole economy
just getting more expensive? And inflation, well, it leaves a
whole lot of folks reacting to it without a plan.
So think of today as a user's guide to living
with inflation. I'm going to give you one big idea,
one reason that inflation is so confusing, and then five
practical things you can do to protect yourself. Let's start
with the big idea. Economists use two very distinctive words
that they sound wonkey. The ideas are dead simple and
very important. A nominal number is just the dollar amount.
Nominal means name, it's the name on the price tag.
A real number is what that dollar can actually buy.
We call it real because it's the one that really matters.
And so when inflation arrives, that distinction becomes more important,
as does your focus on real rather than nominal variables. Hey,
here's a thought experiment. It's kind of wacky, but hopefully
it helps make the point. Imagine you wake up tomorrow
and every dollar figure in the economy has an extra
zero on the end. Your hourly wage goes from twenty
dollars to two hundred, Your rent goes from two thousand
to twenty thousand, your coffee goes from four bucks to forty.
Your savings account it goes from three thousand to thirty grand.
At first glance, this looks terrifying. Everything looks wildly more expensive.
But hang on, See in this economy, your wage is
ten times higher too, says everything else, And so all
we have is a whole lot more zeros. But nothing
real has changed. The trade offs that you face, the
number of hours that you need to work to be
able to afford, say a couple of beers, that hasn't changed,
And that is the difference between nominal and real. Nominal
is the number printed on the page. Real is what
that number can actually buy. One of them's dressed up
in dollar science, the others the one that matters. And
so in our thought experiment, there's a huge change in
nominal variables. But because your income has an extra zero,
as does the cost of everything, none of the real
variables have changed. Look, this distinction matters because it turns out,
of course you know that inflation feels awful. People see
the price rise first and then they feel the squeeze,
and if your income hasn't quite caught up yet, that
pain is absolutely real. So I'm not asking you to
ignore that. I'm asking you to take a second step.
Don't just ask did the number? Say the price go up?
Ask what happened to what I can buy? Because if
your wages, if they rise with inflation, then you've been
made whole. If the interest rate on your savings rises too, well,
that's going to help offset the damage. Now I get it.
Sometimes those offsets can be partial, and they take time.
Keeping track of them really does matter. Now, all this
works in reverse to a bigger paycheck, in fact, only
be worse off if prices rise even faster. A bigger
account balance can still mean you're going backwards if the
interest you earn is less than the amount that inflation took.
That's why when inflation hits, if you can't afford to
think only in dollar size, you've got to think in
purchasing power. Now there's a problem here, another problem. Bigger
dollar amounts can fool you. Economists have a name for
the mistake that people make here. We call it money illusion.
Money illusion is just when you focus on the dollar amount,
the number of dollars you have, or the number of
dollars you get, or the number of dollars something costs,
instead of what the dollars can buy. Mate. This is
one of the easiest mistakes to make in economics because
the big number, the nominal numbers right there in front
of your face. And almost all the big players in
the economy, your boss, the store, the bank, they talk
in terms of nominal prices, and they almost never focus
you on the real trade offs. That's your job. Hey,
let me make this personal. Last year, my boss, the
dean no less. She proudly announced to the faculty that
we're all going to get a two per pay rice.
She was smiling as she said it, except inflation was
running above two percent, so this wasn't good news. She
was offering a real wage cut. She's effectively saying, we're
going to pay you more dollars, but those dollars are
going to buy you less stuff, and the sneaky bit.
It's this because the number on the paycheck went up
by two percent. A lot of people, a lot of
my colleagues in the room, didn't quite register what had
just happened. Nobody stood up and said, hang on, you're
boasting about cutting our real wages and our ability to
buy stuff. I'll be honest, I didn't say to either.
I'm an economist. I ran the numbers later alone in
my office like a coward. That's money illusion. And the
point of this story is that even public policy professors
fall for it. You see the same thing with savings too.
Your bank starts paying you more interest. That feels reassuring.
Fair enough, If inflation's hiding the interest rate, you're purchasing
power is still leaking out the bottom. That's the way
inflation fools people. It confounds real changes in living standards
together with purely nominal changes in the size of the numbers. So, yes,
the pain people feel during inflation is real. But the
right way to measure that pain isn't by staring at
just at what happened to the sticker price. It's by
asking what happened to your real wage, your real savings
return and what your money can actually buy. That's the
mental shift I want you to make, and once you
make it, you're ready for the second problem. Inflation, you see,
makes the signals harder to read. It's like driving through fog.
The road's still there, the destination still there, the car
still works, but the signals are harder to read. That's
what inflation does. You see one price at the store jump,
What are you supposed to conclude? Is this thing now
genuinely scarce, demand searched, did the sellers cost for making
that one thing rise? Or is this just the general
fog of inflation drifting across the whole economy. That matters
because prices are supposed to help us make decisions. There's signals,
there's signals about opportunity costs, but inflation makes those signals fuzzier,
and the fog gets worse when inflation itself is jumpy. Hey,
let me show you. I'm going to jump into Stata
for a second, because this is exactly the sort of
thing where a little bit of data can make the
point much more easily than a thousand words of punditry.
I'm pulling headline inflation here straight from Fred and I
want to know two things about each of the last
few decades. First, for each decade, I want to know
what was the average inflation rate, and second, how much
did inflation bounce around within that decade. I'm going to
use the standard deviation to measure that, and the pattern
it's really clear. The fifties and the sixties we had
low and stable inflation, and then in the seventies and
eighties we've got high inflation, and you know what came
with it, It became a lot less stable, and then
over time we got better monetary policy, and over the
past few decades we're back to lower and more stable
inflation again. But whether that sticks with us, there's still
something of a question. So what you see from this
is that the high inflation decades that were also the
wobbly decades. And that's a big deal because when inflation
is low and steady, folks like you, whether you're at
home or at work, you could mostly just get on
with your life. You can mostly just ignore inflation when
it's lower, because even if your decisions are not exactly right,
they're going to be roughly right, and often that's good enough.
And when inflation's stable, you know, most of what's coming,
so you can plan it around it anyway. But when
inflation's high, it also tends to jump around a lot,
and then you've got to pay attention. That's because when
you've got high inflation, the gap between a smart choice
and a sloppy one gets a whole lot bigger. You're
going to have to compare prices a whole lot more carefully.
You've got to think harder about whether your pay is
keeping up. You've got to stop leaving fixed dollar amounts
sitting there while the world moves on around them. That's
what I mean when I say that an economy with
inflation it's like driving through fog. I want to make
one more practical point. The official inflation rate, the one
you hear about on the news, that's an average. It's
an average for the average cost of living for a
typical American. But you your life's not average. If most
of your budget goes on rent or gas and childcare
and medical bills, your personal inflation experience may end up
looking quite different than the official number. And that matters,
because the point of paying attention to inflation. It's not
to want an economics trivia quiz. It's to make better
decisions for you and your family. So use their headline
inflation number as a warning light, but then go back
look at your own budget as well. Where are you
getting hit? That's going to be the question. It's going
to lead you to better actions. I deeply want you
to succeed even during periods of high inflation. So here's
five pieces of advice that I think you ought to
think about following. First, stop thinking in dollar signs alone.
If your wages go up, ask whether they went up
more or less than prices. If your savings accounts starts
paying you more interest, ask whether that higher interest rate
is above or below the inflation rate. If something costs
more than it used to, ask whether it's actually become
less affordable relative to what's happened to your income. Look,
all of this sounds obvious once you say it out loud,
but it really changes the decisions you make. If you
were to make the mistake of seeing a nomenal pay
rise and really reacting to it, even if it's not
a real pay rise, you might loosen your household budget,
start spending a whole lot more and more freely save less.
Discover later on that your groceries and your rent and
your mortgage and everything else rose fast and you're paid it,
and then it's going to be really hard for you
to make ends meat. So the first move I want
you to make is mental, but it has really practical consequences.
That first move, translate everything into real terms before you act. Second,
find ways to build inflation into the contracts that govern
your life. Fun story years ago I made of mine
was negotiating a pay deal. He was earning one hundred
grand a year. Boss offered him a contract that would
raise his pay by five percent over five years. He
was chaffed. He was excited to get a pay rise,
but I pointed out to him that inflation was running
around about two percent a year, so over five years,
the price level would actually rise by about ten percent.
So let's look at the same offer and real terms,
his pay rises five percent, the price level rises ten percent,
and so he learns that at the end of the
day's boss was actually offer him a new contract that
would buy him less, not more. It was a real
pay cut for him. That was an AHA moment. The
offer looked generous in nominal terms because the number on
the paycheck got bigger, but once he shifted his reference point.
Once he stopped asking is my salary bigger? And started
asking will my purchasing power be preserved? The whole negotiation changed.
That's what I mean when I say, make your real
wage the reference point in any negotiation. You start the
conversation here, walk in. Tell you boss, say first I
need to be made whole for inflation, and then we
can talk about whether I deserve an actual raise on
top of that. That's a much stronger place to negotiate from,
and where you can build that logic into the contract itself,
building cost of living adjustments or indexation clauses or escalator rules,
all those words. Honestly, they sound so dull. They might
be the dullest words I've ever spoken. But they also
might save you thousands of dollars over the course of
a contract. For sure they did for my mate. And
so this advice that applies to more than just wages.
If you work for freelance rates, or if you pay
child support, or if you demand child support, or if
your company is involved in long term service contracts, or
any arrangement at all where a fixed dollar amount could
quietly shift in real value over time, then this is
a tool that you want to use. Third, I want
you to shop around more and substitute more aggressively during
times of higher inflation. Here's why. You see, when inflation's low,
price differences across stores and brands. They don't move around
all that much, and they don't move fast. So living
a financial life on autopil it's mostly fine. It's only
what inflation is higher, and especially when it gets to
be uneven, the prices start to adjust in different times
at different places. One seller reprices this week and the
next reprice is next month. One brand jumps, another doesn't.
One supermarket passes cost through quickly, another drags its feet.
All of that chaos means that there's a far greater
payoff to paying attention. So this is the moment. Compare supermarkets,
Compare insurance. Have another look at your different cell phone
plans and your different options. Compared the usual brand with
the generic. Compare the chicken with the pork or the beef.
Compare one cell who updated prices last week with another
who hasn't caught up yet. Periods of inflation have always
been periods where shopping around pays off more than usual. Fourth,
I want you to hold less idle cash. I'm not
telling you to get rid of cash altogether. You need it.
It's convenient. You can pay bills, buy ice creams, pay
for emergencies. Look, I'm a dad, I get it. But
when inflation's high, interest rates are usually higher too, And
that means that the opportunity cost of holding cash rather
than having that money savings account is a whole lot higher.
Every dollar that's sitting idle in your wallet, or sitting
in an account paying next to no interest, that's a
dollar losing purchasing power fasted, and that needs to so
take action. Keep less cash sitting around doing nothing, Move
more of it into those places where at least it
has a chance of keeping up. Use the savings account
that actually pays interest with the excess cash out of
your checking account. If you can, don't leave money falling
asleep when inflation's awake. Fifth, I want you to find
clever ways to head your inflation risk when it's available.
To be clear, I'm not going to go all finance
bro on you here. The goal isn't to gamble. The
goal is to preserve your purchasing power without too much work.
What you want is to find those tools that are
actually designed specifically to protect you against inflation. The clearest
example is what we call inflation indexed bonds, government bonds,
where the interest rate the government pays you rise with inflation.
In the United States, we have something called Treasury inflation
protected securities. They're called tips for short, or you can
get inflation linked savings products like eyebonds. There are similar
products in other countries, they just have different proper nouns
that go with them. Beyond inflation indexed bonds, the broader
principle is to avoid leaving much of your wealth in
those forms that are fixed in nominal dollars while prices
a rising cash is the obvious example of what you
want to avoid, but so's a checking account that pays
next to nothing, or your Venmo account or maybe even PayPal.
Share prices tend to rise with inflation, as does the
interest rate that banks pay on savings. Look, I'm not
trying to tell you there's a magic inflation trade that
I want you to go out and chase. Lifes too
short for all of that. The point is to make sure, though,
that your financial life is not built on a set
of claims that stay fixed even as the price level
rises and the value of those dollars shrinks. That's the
practical lesson. Okay, what about the deeper lesson here? The
broader takeaway here is inflation reminds you, I think of
something even deeper that pervades all of economic life. The
number that's in front of you, the number itself, it's
often the least interesting thing going on. What matters far
more is what the number means. So good economics involves
the habit of always asking the second question, what does
this number really mean? A nomenal price, well, that tells
you how many dollar bills go out of your pocket.
But what it really means in opportunity cost terms is
measured in real terms. And look, this habit of asking
what does it really mean? It's much bigger than inflation.
It matters for every part of your life. It's how
you avoid being fooled by flashing numbers, by political spin,
by dodgy comparisons and charlatans. It's how you keep bearings
when the measuring stick itself starts moving. And that lesson
that is the real user's guide to living with inflation.