You may have heard that inflation hit its highest point in 40 years but what does that imply and how does it affect you? Let's begin with the fundamentals.
What Causes Inflation?
Causes of inflation generally break down into two categories, demand-pull inflation and cost-push inflation. In regards to current inflation, the main contributing factors include the increase in the money supply, worker shortages and rising wages, supply chain disruption, as well as fossil fuel policies.
Inflation is a phenomena in which the price of goods and services in a given economy rises over time. Have you ever heard someone mention how you could purchase a Coke for a cent in the 1960s? Inflation has reduced the relative value of money in relation to the price of products, which is why a soda now costs $2.
In general, economists are concerned about two types of inflation. In this piece, we'll go over those two reasons, as well as the factors that affect inflation, as well as how experts recommend we combat inflation and what you can do about it. But first, let's take a look at the present sources of inflation and how they're affecting your purchasing power right now.
4 Main Causes of Inflation in Our Current Economy
You may have noticed that costs have been rising on everything from groceries to gas in recent months, with consumer prices up 8% from this time last year. Inflation has that kind of power. But what is it that is currently producing inflation and putting a burden on your wallet?
In the contemporary economy, there are a few factors that contribute to inflation:
1. Increase of the Money Supply:
The purpose of increasing the money supply is to assist boost the economy by putting more money in the hands of consumers. While this may appear to be a positive change, it can have negative consequences for the economy, such as leading to inflation.
Over the last two years, the Federal Reserve has produced trillions of dollars, contributing to the depreciation of the US dollar and the present high inflation rate—which is expected to continue.
Furthermore, the money supply has grown faster than the rate of output, contributing to shortages. Furthermore, with more money in circulation, consumers have more money to spend, resulting in increased consumer demand.
However, because demand exceeds supply, there are numerous shortages across the country.
2. Supply Chain Disruption:
You've probably had trouble buying some things in recent months, whether you're in the grocery store or waiting for something to arrive from overseas. A number of elements are at play in the current situation.
For starters, many businesses cut back on production during the pandemic's peak because consumers were unwilling to purchase. However, they are now, and businesses are scrambling to keep up.
When you combine it with a general shortage of supplies to create particular things, you have a compounding problem.
We haven't even discussed the traffic congestion at various ports across the country, which have resulted in a large volume of cargo being stranded for months at a time. Because goods are detained at these ports and unable to be unloaded, many shelves will remain empty.
3. Government-Sponsored Unemployment:
Increases and extensions to existing unemployment programs were made on both the state and federal levels in response to the spike in job losses we experienced in 2020. While this may have helped many people get back on their feet, we're now witnessing long-term effects that are hurting current inflation, with many individuals refusing to return to work for prior wages—combined with concerns about health and safety.
The crux of the problem is that government-sponsored unemployment benefits compensate people not to work, resulting in a labor shortage. As a result, employers are forced to raise pay above the level of unemployment benefits.
As a result, firms are being forced to pivot and restructure their remuneration and employment strategies. Many small firms will not be able to respond to the need for greater pay in order to ensure that they have the people they require to maintain their operations.
4. Poor Government Policies:
Inflation can be influenced by bad government policies, the most relevant of which are those concerning fossil fuels in our current situation. If you own a car, you've probably seen an increase in gas costs in the last year.
While these policies must be changed, it is not a simple task. Hurricane Ida, which disrupted oil supply, has caused a drop in US oil production and refining this year. There are supply limits on both sides of the equation when oil-exporting countries do not provide enough.
Prices are unlikely to fall in the near future due to supply constraints and ongoing increases in demand for gasoline.
Let's look at inflation causes from a broader perspective now that we have a better understanding of what elements are contributing to inflation most lately.
What Are the General Causes of Inflation?
It's critical to take the time to learn more about inflation as a whole so you can better grasp how and why it occurs, as well as how it affects the economic impact consumers face.
Inflation is caused by two broad, general reasons. Each is a distinct sort of inflation that necessitates a different governmental response. Inflation is caused by two basic factors:
Demand-pull inflation: Inflation driven by demand occurs in a robust economy. People's incomes are rising, they're being paid more, there are more people working, and they're demanding more goods and services. This reduces the overall amount of products and services available because more individuals can afford the limited supply of goods and services that are already available. As a result, prices rise. In general, some demand-pull inflation is a sign of a healthy economy, as it indicates that people are working and earning enough money to consume everything that is produced.
Cost-push inflation: Cost-push inflation is characterized by an increase in the cost of commodities as a result of supply-side factors. For example, if raw material costs rise dramatically and enterprises are unable to keep up with output of produced items, the price of manufactured goods on the market rises. Natural disasters, pandemics, and rising oil costs, for example, could all lead to cost-push inflation. Cost-push inflation can be caused by a variety of factors, and it's something policymakers should be concerned about because it's tough to control.
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
Direct: 952.828.5336
Email: kurt@ivoryhill.com
—Written 03.31.2022
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