Inflation has skyrocketed during the previous 18 months, reaching 40-year highs this summer. It is currently above 8% on an annual basis. Inflation is essentially caused by too much money in the hands of buyers and not enough goods to purchase in the marketplace. Government-mandated Covid shutdowns decreased the supply of goods worldwide. In addition, the government flooded the market with trillions in stimulus money for consumers to buy goods and services. This combination created the perfect storm of inflation we now experience.
The Federal Reserve is combatting inflation by increasing interest rates. The Fed has raised interest rates throughout 2022 and are expected to continue doing so through year-end. Higher borrowing costs usually slow economic activity by reducing demand for goods and services. This is especially true for big-ticket items like real estate, vehicles, etc. Mortgage rates have gone from 3-4% to 6-7% or more currently. In addition, as credit card interest rates rise, people tend to use them less to buy goods or services. Effectively, the Fed is trying to dissuade consumers from buying goods to slow demand.
Historically, high inflation followed by interest rate hikes is then followed by a recession. Many politicians and economists predict a recession to occur in the United States in the coming months. The severity and duration of a potential recession is a matter of opinion and debate. Predicting the future is difficult, even for really smart economists and politicians. Oxymoron intended.
What does this mean for your small business? Profits may be good in 2022, but if a recession does come, profits may be down or even nonexistent in 2023. Thus, 2022 year-end tax planning may be important.