We’ve all heard the numbers. Inflation is running around 7% — the highest in 40 years. “Transitory” was the word used at first, but last November Fed Chair Jerome Powell said, “I think it’s probably a good time to retire that word.”
Fine — retire it. But what does this lasting jump in inflation mean? If you’re thinking about long-term finances, how should you respond and how much do you need to make up for it?
Right now the consensus is that inflation will settle back to 2–3% sometime in 2022. But what if that’s wrong? Let’s look at some simple math to see what a spike could do to our ability to save.
Example: a 48-year-old planning to stop full-time work at 62. Under a steady 3% inflation assumption (income and expenses rising about 3% per year), this person is projected to have about $200k saved at age 90 — a comfortable cushion.
Now add a one-year, 7% spike in inflation for expenses. That single year of higher inflation cuts about $130k from their projected savings over the next 40 years.
If the spike lasts two years, the result is worse: the cushion disappears and the model shows the person ending up about $80k short by age 90 after just that two-year surge.
That’s a big change and it’s worrying — but it’s not the whole story.
Look back over the past 50 years: while current rates are higher than the last decade, there have been shorter periods that approached today’s levels (some months in 2008, for example). The 1970s were unusually severe and long-lived by comparison. Saying “at least it’s not the ’70s” helps a little, but only so much.
Another important factor is human behavior. When beef gets expensive, people buy pork. When dealers push car prices above MSRP, buyers delay purchases. In practice, inflation often changes what and how much people buy, so its “real” hit to a household budget can be smaller than headline inflation suggests — assuming alternatives exist and inflation hasn’t become entrenched.
Also, inflation often comes with rising wages, though not always at the same pace. If we model both some wage growth and reduced spending on higher-priced items, the outcome looks much less dire. In that adjusted scenario, a two-year 7% spike cuts projected savings by about $40k over 40 years, but the overall cushion is mostly preserved.
The takeaway: reality is messy. The math of an inflation spike should guide short-term choices and long-term plans, but numbers don’t tell the entire story. As statistician George Box said, “All models are wrong, but some are useful.” So don’t panic — but maybe think twice before buying that new truck.
All visual models were created using OnTrajectory.com. Read Cubert’s review of this useful retirement calculator: OnTrajectory – A Feature Rich Yet Easy Retirement Calculator.