Inflation Is High – Can Debt Actually Make It Your Best Friend?

Inflation is what economists call it when prices go up. There are many inflation measures, such as the well-known Consumer Price Index (CPI), the “chained” CPI, the Producer Price Index (PPI), etc., all of which measure how different prices change over time.

What Happens When Inflation Soars

For loans you need to pay off in a handful of years, especially when the balance isn’t very high, the impact of inflation doesn’t usually make a big difference.

How Inflation Affects Debt May Make You Smile

Here’s What Determines If High Inflation Helps or Hurts You

There are 4 factors that affect whether high inflation is your enemy or friend.

- If your income doesn’t keep up, inflation makes it harder to cover your expenses – Enemy! - If your income goes up enough to keep up (or better yet, exceed) inflation – Friendly!

Does your income keep up with inflation, e.g., through cost-of-living adjustments (COLA)?

Do your assets keep up with inflation?

- If you keep a lot of your assets in checking or savings accounts that pay less interest than inflation, your real (inflation-adjusted) net worth is dropping – Enemy! - If most of your assets have higher (preferably much higher) returns than inflation, especially if pumped up by inflation – Friendly!

- If you’re in a high tax bracket, you pay taxes on “phantom gains” when inflation sucks out much or all of your gains, yet you’re taxed on nominal gains – Enemy! - If your tax bracket isn’t very high, this is less of a concern – Neither.

Are you in a high tax bracket (federal + state + local)?

Do you have large, long-term, fixed-interest-rate debts?

- If you have any short-term debt at any interest rate – Friendly! - If you have no debts on which you pay interest – Neither.

The overall impact you suffer or enjoy when inflation soars depends on where you fall on each of the above 4 factors, and how significant each is relative to your financial situation.

The Bottom Line

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