Before I continue with the discussion of financial literacy, I want to take a step back and explain some economic indicators. These indicators play a big role in the health of our economy, which in turn affects how much money goes into your pocket and what you can do with it. So let’s get started.
Inflation
Inflation is the change in prices of goods and services over a period of time. This means $100 today will not be worth $100 one year from now. For example, with 3% inflation, $100 one year from now would be worth $97. Inflation affects the value of money in your pocket, which means you won’t be able to buy as much with the same amount of money. Inflation also affects the money in your savings accounts. If the inflation rate is higher than the interest rate of your account, the real value of the money will decline.
As of right now, inflation is around 2.5%, which is surprisingly low. This could be due to the Federal Reserve’s interest rate increases since 2022, which have slowed inflation. The higher cost of borrowing has decreased demand for goods and services, which means businesses aren’t raising prices as much. But that has effects on unemployment, which reached 4.3% in July, a level the U.S. hasn’t experienced since 2017.
Unemployment
As I said, unemployment in the U.S. in July reached 4.3%, and as of right now, the unemployment rate is about 4.1%. Unemployment affects the economy by slowing economic growth. About 70% of the U.S. GDP comprises consumer spending. Unemployment puts more people out of jobs, meaning less disposable income, which reduces consumer spending.
But unemployment also affects the individual consumer. Unemployed people have less income to spend, meaning they find it more difficult to pay their expenses. Unemployed individuals losing their purchasing power can create a ripple effect through the economy in which even more individuals become unemployed. The decrease in spending throughout the economy means demand for goods and services is less, leading to businesses producing less and trying to cut costs by laying off more workers. This ripple effect is a good example of why unemployment also affects employed individuals.
GDP
I talked about GDP in the discussion about unemployment because the two indicators are connected. Higher and rising GDP signals a booming economy, where consumers have more money to spend and unemployment is lower, leading to more production, higher wages, and healthier finances of individuals. Lower and decreasing GDP signals the opposite. Additionally, increasing GDP typically means the stock market is performing better (as businesses are performing better), meaning individuals can get more returns on their investments. But rapidly rising GDP can also cause inflation (which we talked about above), and that can erode purchasing power.
This shows the interconnectedness of all three economic indicators and why the Federal Reserve has to account for all three when implementing economic policies. But more importantly, it sheds light on why every citizen must understand the effects certain factors have on our economy and the equally significant effects they have on personal finances. It doesn’t mean you can wake up the next day and implement a policy that creates just the right amount of inflation so that you can afford the new iPhone. It means if you understand these economic indicators, among others, and their effects on our economy and your own individual finances, you will be able to make better decisions and get one step closer to creating long-term wealth.
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