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.
Meet Your Retirement Goals Effortlessly
The road to retirement may seem long, but with WiserAdvisor, you can find a trusted partner to guide you every step of the way
WiserAdvisor matches you with vetted financial advisors that offer personalized advice to help you to make the right choices, invest wisely, and secure the retirement you've always dreamed of. Start planning early, and get your retirement mapped out today.Get Started
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.
2022-2024 inflation rates
Stop overpaying for home insurance
Home insurance is an essential expense – one that can often be pricey. You can lower your monthly recurring expenses by finding a more economical alternative for home insurance.
SmartFinancial can help you do just that. SmartFinancial’s online marketplace of vetted home insurance providers allows you to quickly shop around for rates from the country’s top insurance companies, and ensure you’re paying the lowest price possible for your home insurance.Explore better rates
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 $412,000 in September 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.
The benefits of inflation
We have an idea of what inflation is and what the Federal Reserve can do about it. Now it's time to get into the meat of the matter: Why would the Federal Reserve want inflation?
Benefit #1- sign of healthy growing economy
To begin with, inflation is a sign of a healthy growing economy, as long as it is managed. Think about it. If you know that next year's prices will be higher than they are now, you make your purchases now rather than waiting, saving, and paying more later. This is, in essence, what low inflation does. It spurs spending in an economy, which is the key to healthy growth. Consumption leads to business growth, which leads to wage and employment increases, which leads to more consumption.
Benefit #2 – protection from deflation
The second major reason the Fed wants inflation is that it means the economy won't teeter into deflation, which is the opposite of inflation. In a deflationary environment, prices are constantly going down. This sounds great at first glance, but think about what would happen in reality.
People expecting lower prices next year would hold off on purchases and save their money instead. This would cause consumption to stop. Businesses would need to cut wages or lay off employees. Next thing you know, you have a death spiral of lower prices and lower consumption, leading to a stagnating economy.
Suddenly low prices doesn't sound so great, right? We have a perfect example of a modern industrial economy that is facing this very issue: Japan. Japan's had a deflation problem for decades and still hasn't found a solution. This probably worries the Federal Reserve as it also would not know how to counter such a problem.
To make sure the U.S. doesn't become the next Japan, the Fed wants at least a little inflation. This is especially important now as, despite its best attempts, the Fed has failed to get inflation to rise to its 2% target.
Benefit #3 – Decreases real value of debt
The final reason the Fed wants inflation to rise is that the real value of debt decreases in an inflationary environment. Inflation is actually terrific for the indebted — such as people with a mortgage on their house — as their loan value gets cheaper as inflation rises.
And guess who happens to hold a large amount of debt? The U.S. government holds the most amount of debt in the world in absolute terms. It holds an astonishing amount that it is widely agreed that the government will never be able to pay it back.
Letting inflation run would actually give the U.S. Treasury a breather in dealing with its interest payments, which is an issue that has become particularly acute after the huge amount of money spent to stimulate the economy in response to the coronavirus pandemic.
Inflation’s stubborn hold on U.S. economy
We can all agree that inflation has overstayed its welcome in the U.S. economy. Exactly when its grip on consumer wallets will begin easing is anyone’s guess, but several key factors will determine whether prices come down – or keep going up.
Inflation in the U.S. may be easing slightly, but it remains well above the Federal Reserve’s target rate of 2% – and continues to add to bills of all kinds: Groceries. Clothing. Dining out. Vacation flights.
In December, inflation rose by 0.3% rise to 3.4%, following a 0.1% increase in November and raising questions about just how many times the Federal Reserve would cut rates in 2024.
Though inflation remains far below the 6.5% that plagued consumers in late 2022, a hot labor market and the lingering effects of the pandemic have kept inflation uncomfortably high. Why has it been so hard to shake?
Why is inflation so high right now?
The story of inflation typically starts and stops with supply and demand imbalances. The global pandemic caused major disruptions to supply chains, leading to shortages of goods and materials. These shortages still ripple through the economy, pushing up prices.
At the same time, government stimulus programs and accumulated savings have increased consumer spending, creating additional demand for goods and services that the constrained supply chains struggle to meet, further driving up prices. Rising wages, which lead to increased spending and further inflation, are helping to keep consumers in what feels like a constant inflation cycle.
Global tensions aren’t helping. The Russia-Ukraine war has significantly disrupted energy markets, leading to higher oil and gas prices, which impact transportation costs and contribute to broader inflation. And rising trade tensions between the U.S. and China, along with other countries, create uncertainty and disrupt trade flows, potentially influencing inflation through supply chain issues and import costs.
Amid all those negative pressures, even good news doesn’t always help when it comes to inflation. The U.S. labor market remains strong, with low unemployment and high job openings – a competition for labor that puts upward pressure on wages. Businesses are pretty good at passing that cost onto consumers.
Will inflation go down in 2024?
Some economists believe inflation will ease in 2024. How might it happen?
Adjustment of supply chains: As global supply chains recalibrate and adapt to post-pandemic realities, this could alleviate some price pressures.
Monetary policy tightening: The Federal Reserve has signaled its commitment to combating inflation. While the market in late 2023 largely interpreted recent Fed moves as a sign that rate cuts would come in 2024, others remain unconvinced. The Fed can always use rate hikes and other monetary tightening measures, which could gradually mitigate inflationary pressures.
Decreased fiscal stimulus: With the reduction of pandemic-related fiscal stimulus, there’s simply less consumer cash moving in the market, which could help cool prices off
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.
With files from Chris Clark and Isaac Aydelman
Follow These Steps if you Want to Retire Early
Secure your financial future with a tailored plan to maximize investments, navigate taxes, and retire comfortably.
Zoe Financial is an online platform that can match you with a network of vetted fiduciary advisors who are evaluated based on their credentials, education, experience, and pricing. The best part? - there is no fee to find an advisor.