A June 2023 Forbes article, The Price is Right: U.S. Inflation Hits Two-Year Low in May a combination of higher interest rates, easing supply chain challenges, and more restrictive credit has helped ease inflation in 2023. As of this past May, the annualized rate of CPI inflation declined for the eleventh consecutive month.
However, many people are still a little unsure about what causes inflation and how it may actually affect their financial strategy, so this month we’re providing a little inflation 101. An Investopedia article, Inflation: What It Is, How It can Be Controlled, and Extreme Examples provides some useful insights and information.
What is inflation?
Inflation is a rise in prices and a drop in purchasing power over time. The level at which purchasing power falls can be shown in the average price increase of a basket of selected goods and services over a defined period of time.
An Investopedia article, Basket of Goods: Definition, CPI Calculation, and Example explains that here in the U.S., each month the Bureau of Labor Statistics collects the prices of around 94,000 items from a scientifically chosen sample of goods and services and gathers them into a representative sample.
Here’s a quick recap of some key takeaways when it comes to understanding what inflation is:
• Inflation is the rate at which the costs of goods and services increase
• Inflation is sometimes classified in three categories: demand-pull, cost-push, and built-in
• The most used inflation indexes are the Wholesale Price Index and the Consumer Price Index
• Depending on your personal view, as well as the pace of change, inflation can be viewed either positively or negatively
• People with tangible assets like property or stocked commodities may prefer to see some level of inflation because it may increase the value of those assets
From a data standpoint, it’s fairly straightforward to track price changes of a few products over time, but people rely on more than just one or two or even a small handful of products and services to meet their basic needs. They include things like grains, metal, fuel, healthcare, entertainment, utilities and more.
That’s why inflation seeks to determine the broad impact of price changes for a range of products and services. It provides a single value representation of the increase in the price level of those goods and services in an economy during a set period.
A rise in prices means that our money can purchase fewer goods and services. That loss of purchasing power negatively affects many people’s cost of living and that ultimately leads to reduced economic growth.
Causes of inflation
A rise in the money supply is the root cause of inflation, though it ultimately plays out within the economy in various ways. A nation’s money supply can be increased by monetary authorities by:
• Printing and offering more money to its people
• Legally devaluing legal tender currency
• Loaning new money as reserve credits via the banking system by purchasing government bonds from banks on the secondary market, which is the most typical method
In each of these examples, money ends up losing purchasing power. The mechanisms behind why this drives inflation can be lumped into three categories: demand-pull inflation, cost-push inflation, and built-in inflation.
Three types of inflation
We see demand-pull inflation when there’s an increase in the money supply and credit stimulates the overall demand for goods and services to increase quicker than the economy’s production ability. This increases demand which can then lead to price increases.
Cost-push inflation occurs when the rise in prices work through the production process. When increases to the money supply and credit funnel their way into a commodity or other asset market, the costs of numerous intermediate goods, jump.
Built-in inflation is related to changing expectations or the notion that people expect current inflation rates to continue. As prices rise, and people expect those increases to continue, they may demand higher wages to offset those rises and maintain their lifestyle.
SOURCES
https://www.forbes.com/advisor/investing/current-inflation-rate/
https://www.investopedia.com/terms/i/inflation.asp
https://www.investopedia.com/terms/b/basket_of_goods.asp
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