Economists say prices will jump this year

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January 25, 2004|By Julie Claire Diop

America is in the midst of what has been called "a Goldilocks economy" (not too hot, not too cold), with record growth and stable prices. It may seem premature to worry about inflation, but most economists agree that a jump in prices will be a threat sometime in 2004.

Of course, the growth of this fairy tale economy hasn't included a growth in jobs or wages, and that's been especially hard on younger people in the labor market. When the economy does heat up, it is hoped that earnings will, too. But more income doesn't mean a thing if prices go up faster.

High inflation also makes it more expensive to borrow money. If the price of a car in one year is expected to jump from $10,000 to $11,000, a bank must charge 10 percent interest just to keep up with inflation, never mind make a profit. Car dealerships and computer stores will retire their zero-percent-financing signs when prices go up.

If each dollar buys fewer goods, then investors will prefer to hold on to other currencies, such as the British pound or the euro. This will make the dollar weaker than it already is, and as they flee from the dollar, foreigners will demand more greenbacks for their products. The Mini Cooper or Volkswagen Bug you had your eyes on will suddenly be much more expensive. So, too, will the vacation you planned to London or Paris.

Inflation is not bad for everyone. My husband and I have a condominium, two cars and lots of schooling. In other words, we have a significant amount of debt. Fortunately, we locked in pretty low interest rates. If our salaries rose as prices rose (which may be wishful thinking), our monthly debt payments would become a smaller portion of our income. We'd be much better off, since most of our salary does not go to new purchases, but to paying off old ones.

Most 20-somethings don't have enough money to need to worry about inflation.

Paying off credit-card debt and saving enough money to live salary-free for three to six months - just in case a job disappears - should be the top priorities, says American Express financial adviser James Law. If there is money left over, Law said, put it in a well-diversified 401(k) retirement plan. The stock market historically has served as a hedge against inflation.

Because interest rates are expected to rise as the economy revs up, don't stow your savings in long-term interest-bearing investments, such as five- or 10-year certificates of deposit. If you're reluctant to put your money in the stock market, make shorter-term investments until interest rates bounce back to higher levels.

I wouldn't rush to pay off student loans. Putting your extra money into a mutual fund or retirement plan will likely reap you more than the 3 percent or 4 percent you save in interest payments, especially because these payments often are tax deductible.

In the end, it's best to make decisions based not on whether prices will rise or fall, but on whether you've finished paying off your credit cards, have some savings, and need a new car or are ready to become a homeowner.

You may be tempted to quickly buy an apartment or house before the economy heats up and interest rates rebound. But first make sure you want to be a homeowner. Real estate prices are high - many economists argue there's a real estate bubble.

As interest rates go up, so will mortgage payments. To offset that, buyers will likely strike harder bargains, causing prices to dip slightly. By rushing, you could lock in a low rate. By waiting, you might get a better deal on your dream place.

E-mail Julie Claire Diop at yourmoneytribune.com.

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