What is inflation?
Inflation is the rate of price increases for goods and services over a given period of time.
For instance, the average cost of a Big Mac meal at McDonald's is about $5.99 today, compared to an average of just $2.50 in the 1990s. That's inflation.
The term itself dates back to 1838 and comes from the Latin word “inflare,” which means to “blow up.”
Nowadays, inflation refers to the general increase in the price of goods and services in an economy.
How is inflation calculated?
Every month, the U.S. Bureau of Labor Statistics (BLS) releases the Consumer Price Index (CPI), which measures the prices that urban consumers pay for a “market basket” of common items, like fruits and vegetables. It also measures the price of services such as haircuts and doctor’s visits. The goal is to measure the average change of prices over time.
The best way to compare inflation rates is by using the end-of-year CPI to see the change.
To calculate this:
Rate of inflation = CPI x+1 - CPIx/ CPIx
Rate of inflation = CPI (new price) - CPI (old price)/ CPI(old price)
The BLS itself offers its own online calculator, which Americans can use to find out how much their money would’ve been worth in the past. The calculator goes as far back as 1913, which is the year the CPI was introduced.
2022-2023 inflation rates
Invest in Real Estate with Just $100
US inflation rate history
Types of inflation
There are four general causes of inflation. The most commonly recognized causes are:
- demand-pull inflation
- cost-push inflation
- built-in inflation
The fourth is a type of inflation caused by an increase in the money supply, due to the Federal Reserve printing more.
Here’s how they work:
Demand-pull inflation happens when demand from consumers pulls prices up. An example of prices going up due to aggregate demand is rising house prices, especially in highly-coveted areas. For example, Portland, Ore., which has been ranked as one of the hottest markets in the country, saw more than a 117% increase in home prices from an average of $246,643 in March 2015 to around $485,475 in March 2023.
Cost-push inflation happens when the cost of producing items increases, pushing the prices higher. An example of cost-push inflation is what we saw during the pandemic.
The onset of COVID-19 led to a series of supply chain disruptions, labour shortages and ultimately rising costs to produce items and provide services. World’s economies are still reeling from this effect, and this is one of the reasons for this inflation.
Federal Reserve chair Jerome Powell himself admitted that in September.
“We would not have seen such high inflation without COVID-19,” Powell said.
Built-in inflation or wage-price spiral is when workers demand higher wages to keep up with rising living costs. This will induce businesses to raise their own prices too, leading to a circle effect.
Does an increased money supply induce inflation?
There is debate on whether the Federal Reserve printing out more money may or may not cause inflation.
Powell still believes that inflation and the money supply are unconnected but he has fierce critics who think otherwise.
Steve H. Hanke — a professor of applied economics at Johns Hopkins University — stated the money supply is growing 13% annually.
Until the pandemic, supply hadn’t grown that much since the late 1970s. Hanke also said that even if the Fed acts swiftly to slash that increase in half, annual inflation will top six percent through 2024.
However, this isn’t always the case.
In 2008-2009 for example, the Fed increased the money supply by over 120%, and this did not cause inflation.
When does the Fed intervene?
The life of a business cycle must be factored in to better explain inflation.
A business cycle is made of four fluctuations — expansion, peak, contraction and trough — in the gross domestic product (GDP).
During the expansionary phase, inflation is at a healthy rate, which is around 2%. But the moment it exceeds that, it creates what economists call an asset bubble, when the market value of an asset grows faster than its underlying real value.
When a bubble bursts, prices crash and demand falls, leading to a contraction in the economy. And that’s when the downward spiral starts and the market starts registering negative growth. And if the economy contracts for more than two quarters in a row, the potential of a recession becomes real.
During recessions and troughs, the Fed uses monetary policies to control inflation, deflation and disinflation.
The effect of monetary policy
During the pandemic, when small businesses were hit hardest and the general demand for many goods and services was affected, deflation was a real concern.
Deflation is bad news for businesses as they start losing money, however, consumers see their purchasing power increase.
The Great Depression in the 1930s is one example of deflation. It is when demand and supply significantly drop, leading to the collapse of not only businesses but also banks.
The most recent example of a deflation is during the subprime housing crisis between 2007 and 2008. It is known as the “Great Recession,” when banks were unable to provide funds to businesses and homeowners were busy paying their debt.
Tobias Adrian — IMF financial counselor and director for the monetary and capital markets department — said in April 2020 that major advanced economies like the U.S. might face deflationary pressures.
And this is when the stimulus checks came in during the pandemic, in order to keep the economy energized and avoid deflation. With three rounds of stimulus checks, the U.S. government gave more than 472 million payments or $803 billion in total financial relief to those impacted by the pandemic.
To continue spurring economic activity, the Feds also lowered its rates.
However, some critics claim that while the stimulus bills were necessary, they have contributed to the inflation we know today.
And this also explains why some economists believe that inflation is the result of a monetary policy.
“Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output,” the late economist and Nobel prize laureate Milton Friedman once said.
Why is inflation so high right now?
The main causes of the current inflation in the U.S. is the persistence of supply disruptions and shortages of food products, which began with the pandemic. Additionally, inflation is also affected by the higher energy prices. The U.S. isn’t the only country experiencing this.
Canada’s inflation also slowed to 5.2% in February 2023, but it is still far above the Bank of Canada’s 2% target. Gas prices are lowering but families are still feeling the impact of inflated food prices.
Some countries are in a far worse predicament when it comes to inflation. In Argentina, inflation hit 102.5% in February 2023; in Turkey, it's 43.7% as of April 2023.
Inflation is not only a result of foreseeable economic changes, but also geopolitical events that cause ripple effects, such as COVID-19 and Russia’s invasion of Ukraine.
As a result of the Russian invasion on Ukraine, and numerous countries imposing sanctions on gas-exporter Moscow, the world felt the commodity shock when energy prices soared high and reached new records. This explains why energy prices reached record highs in many parts of the world.
When will inflation go down?
Overall, the April inflation rate shows that prices have started to decline in key areas, such as gas or airfare, probably indicating that inflation peaked. However, the underlying issues causing this inflation haven’t been solved yet.
In its post-COVID-19 indicators, supply chain firm Flexport said that “overall consumer preferences for goods over services will decline but still remain slightly above summer 2020 and pre-pandemic levels.”
“We’re seeing prices come down and that will help shorten the inflation cycle,” he says. “Both shipping costs and times have come down considerably.”
In addition, maybe there is some silver lining for the supply chains in the United States since U.S. executives are currently thinking of different ways to re-pivot and deal with these supply chain issues.
According to Dodge Construction Network, the construction of new manufacturing facilities in the U.S. has soared 116% over the past year, dwarfing the 10% gain on all building projects combined.
However, it gets complicated with the labor shortage and more baby boomers retiring.
Tips to combat inflation
There are four main ways you can fight inflation in your daily life.
Cut discretionary spending. It is obvious that inflation requires cutting back on discretionary, or non-essential spending and tracking your income.
Bring in more income. Those who are very cash-strapped or want to save more money may take on an extra job.
Take advantage of high interest rates. However, those who have some money to spare can invest in a high-yield savings account or other savings vehicle like a CD.
Eliminate your debts. Also, once interests are up, it’s advisable to refinance any current variable-rate debt.
Kiss Your Credit Card Debt Goodbye
Millions of Americans are struggling to crawl out of debt in the face of record-high interest rates. A personal loan offers lower interest rates and fixed payments, making it a smart choice to consolidate high-interest credit card debt. It helps save money, simplifies payments, and accelerates debt payoff. Credible is a free online service that shows you the best lending options to pay off your credit card debt fast — and save a ton in interest.