How Does Inflation Cause Poverty and Widen the Wealth Gap?

Inflation is a general increase in the prices of goods and services within an economy, meaning each unit of currency buys fewer goods and services over time. Poverty describes a state where individuals or households lack the financial resources and essentials needed to maintain a minimum standard of living. These two concepts are intricately linked, as inflation can directly erode financial stability and push individuals closer to or deeper into poverty.

Erosion of Purchasing Power

Inflation directly reduces the purchasing power of consumers. For example, if the cost of a carton of eggs increases significantly, the same amount of money will buy fewer eggs than before. This makes it harder for individuals to afford what they once could.

When the prices of necessities like food, housing, and energy increase, individuals and families find that their income, even if it remains nominally the same or increases slowly, cannot keep pace with the rapidly rising costs. This situation leads to a decrease in the real value of their wages and overall income. As a result, people can afford less, and their standard of living declines, pushing them closer to or deeper into poverty. For instance, consumer prices were 7.1% higher in November 2022 than a year earlier, with food costs up 10.6% and rent increasing 7.9%.

Impact on Savings and Wealth Accumulation

Inflation significantly devalues existing savings and makes it more challenging for individuals to accumulate wealth. For example, if a savings account earns 1% interest but inflation rises by 3%, the real return on savings is actually negative, meaning the purchasing power of the money decreases.

This erosion of value particularly affects those on fixed incomes, such as retirees or individuals relying on government benefits. Their savings quickly lose value, diminishing their financial security and ability to maintain their lifestyle. While Social Security payments include cost-of-living adjustments, these increases often lag behind actual inflation, meaning recipients may still see their purchasing power erode in the short term. Furthermore, inflation hinders the ability of low-income households to build emergency funds or invest in assets that could help them improve their financial standing.

Increased Debt Burden

Inflation can exacerbate financial strain by influencing debt. While unexpected inflation can reduce the real value of existing fixed-rate debt, making it easier for borrowers to repay with devalued currency, its overall impact on new and variable debt is often negative. The Federal Reserve often raises interest rates to combat high inflation, which in turn makes new loans and variable-rate debt more expensive. This increase in borrowing costs can be seen in credit card interest rates, which often rise in response to inflation.

The rising cost of living can compel individuals to rely more heavily on credit cards to cover daily expenses when their income falls short. This increased reliance on borrowing, coupled with higher interest rates, can lead to a cycle of accumulating debt. For example, credit card balances grew by $45 billion in the fourth quarter of 2024, with some average interest rates on new credit cards reaching over 20%. This makes it increasingly difficult for vulnerable households to manage their finances and escape poverty.

Disproportionate Impact on Vulnerable Groups

Inflation disproportionately affects certain populations, making them more susceptible to poverty and widening the wealth gap. Low-income households spend a larger proportion of their income on essential goods and services, such as food, housing, and energy. These necessities are often the first to experience significant price increases during inflationary periods, leaving these households with less discretionary income and fewer options to cut spending. For instance, low-income households may already be purchasing the cheapest products, lacking the flexibility to switch to even more affordable alternatives when prices rise further.

Individuals on fixed incomes, marginalized communities, and those in precarious employment face particular challenges because they have limited ability to adjust their income to match rising costs. Unlike some workers who might receive wage increases, fixed-income earners often see their purchasing power diminish significantly. This disparity means that while higher-income households might have savings or other buffers to absorb price shocks, vulnerable groups have smaller financial cushions and are more likely to resort to debt or go without. Consequently, inflation exacerbates existing inequalities, pushing the most vulnerable further into poverty and broadening the economic divide between the rich and the poor.