How Inflation Impacts Your Bank Account | NerdWallet

You know inflation is high right now and you're probably feeling the effects on your finances. This can mean going to the grocery store or gas station and spending more money for the same goods, services, and gas that you did a year ago. On the macroeconomic level, inflation has been affecting the economy of the U.S. for a while now, several months at least. But that means that the government has decided to step in and change interest rates as a way to control inflation. Today we're going to talk about inflation, the Federal Reserve, macroeconomics, and how all these things come together to affect your bank account. Inflation is the name of the phenomenon where things become more expensive. Basically, you take the consumer price index, which is a list of goods and services that are available in the economy. And when you track them, you see if prices are going up or down. The U.S. has spent most of 2022 going through a period of high inflation. The current inflation rate is over 8%. You may have noticed that your bank accounts have started offering higher interest rates than they have in the previous couple of years. However, these rates still aren't matching the rate of inflation. So what can you do to adjust your banking strategy to account for inflation? The number one thing you can do to hedge against inflation is to comparison shop for new bank accounts. Even though a lot of these accounts aren't going to beat the rate of inflation, they're going to be a lot higher than maybe the bank account that you have right now. Earlier this year, even high yield savings accounts were only topping out at about half of a percent. Now these bank accounts are tending to offer 2% or higher. Even though that won't match the rate of inflation, it's definitely going to allow you to preserve the value of money longer than if you weren't earning any interest at all. Let's zoom out and look at the basics of shopping for a bank. First of all, you're going to want to look for low or no monthly fees, a generous overdraft policy, ideally a high interest rate, and access to customer service that works for you. Beyond that, you might also want to look into strong services and features on the bank's app, as well as access to a wide ATM network. If you're a little wary about opening a new bank account and closing your old bank account, the good news is you don't necessarily have to close it. You could keep it open and just make sure that you're meeting the minimum requirements to avoid fees. And then when you put money into a new account, you can just test it out and see if you like the rate and if you like the customer service and all the other things the bank has to offer. If you do, you could close your old account, or if you decide you don't like it, you can close your new account. You can really choose your own adventure here and make sure that you open accounts at new places that work best for you. If current rates on savings accounts still feel too low to you, you might want to consider investing. I recently did a whole video about short-term saving versus long-term investing. Go check it out to learn more about how these strategies can work for you. The next step you're going to want to take when it comes to thinking about inflation in your bank account is to keep an eye on what the economy is doing. If inflation seems to be getting too high, then it's likely that the Federal Reserve is going to decide to raise interest rates. So the Federal Reserve is the national bank that's run by the government, and basically its job is to help manipulate the economy so that consumers don't feel negative effects when the economy either slows down too much or speeds up too much with inflation. It controls something called the Federal Funds Rate, which is the interest rate that banks use to borrow and lend money to each other overnight. So typically, a bank will have cash reserves that it's required to have, and if it ends up having cash reserves that are too low, then it will use this overnight system to borrow money from other banks or to lend money to banks that need it. Think about it this way. The Federal Reserve is your bank's bank, and anything that affects your bank is eventually going to trickle down to the consumer products. At the most basic level, if the Federal Funds Rate goes up, that means that it becomes more expensive for banks to borrow money, and those effects end up coming down to consumer products as well, meaning that if the rate goes up, it's a lot harder to borrow money, and it helps slow the economy because people are less likely to be spending money on things they need to finance, like a house or car or any other major purchase that would require some line of credit or a loan. As interest rates go up on things like loans, mortgages, or other vehicles for borrowing money, it also means that interest rates are generally going to go up for things like checking accounts, savings accounts, and certificates of deposit. So what we're saying here is that as interest rates go up on borrowing money, interest rates on saving money generally go up as well. The reason why the interest rate goes up on your savings account is because when you keep your money at a bank, technically that means your bank is able to take that cash on the back end and lend it out to other bank customers. So you'll always be able to access all the money in your account, but the bank is constantly shifting funds around in order to make sure it's able to lend money as well as store it for customers who have savings accounts. As the bank is lending out your money to other customers, they're earning a lot of interest on those loans and mortgages that we discussed a minute ago. So when they're making all that money from the interest rates, they're able to provide a kickback to you on the form of a high interest rate on your savings. They also want to make sure that you feel compelled to stay at that bank so that they can continue to lend out money. So what happens to the economy if inflation starts to decrease? Basically, we start to see an inverse of what happens when inflation goes up. Prices stop rising as quickly and ideally even start to go down. However, if the economy slows too much, the Federal Reserve might step in to lower interest rates. By lowering interest rates, it ends up stimulating the economy by encouraging people to borrow more money for larger purchases. However, if interest rates go down, that typically means that interest rates will go down on your savings account as well. When it comes to the economy, the one constant is change. We've seen inflation go up and down a lot over the years, but thankfully 2022 hasn't been nearly as bad as the hyperinflation of the 70s. And with the Federal Reserve stepping in, hopefully we'll never see something that extreme again. But in the meantime, we just have to adjust the sales of our financial boats and make sure that we keep our savings strong while also optimizing where else we put our money so that we can receive the best interest rates. We can also plan around what the Fed is doing in terms of borrowing money. So if you have any large purchases coming up, see what the Fed is doing and see if interest rates are going to raise or drop. But beyond that, you just have to sort of adjust to what's happening in the economy and keep on moving forward. I'm Chanel Bissette, and I'm a banking writer with NerdWallet. If you're in the market for a new bank account and want to look at the best interest rates, check out the roundups and articles that we have on our site. 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