What is Inflation?
In this article, I will discuss inflation, what it is, and how it has significantly impacted our economy in 2022. To begin, inflation is an increase in the prices of goods or services in a market. As these prices rise, consumers’ purchasing power decreases, meaning their currency is less valuable than it was in previous years. Inflation is typically measured by the average price of a “basket of goods or services,” which refers to consumer spending patterns for commonly purchased items. The Consumer Price Index (CPI), administered by the Bureau of Labor Statistics, is the most commonly used data index to track inflation rates. The Federal Reserve aims to limit the annual increase in the inflation rate to around two percent. When inflation exceeds this rate, it can lead to a decline in the quality of living for many individuals, as it affects prices in all areas of the market, including energy, food, consumer goods, and healthcare. On a larger scale, high inflation rates can slow economic growth as consumers spend less due to rising prices, decreasing the overall money supply in an economy. Deflation, when inflation falls below zero percent, results in a natural decline in most prices of goods or services within a market.
Key Takeaways:
1. Inflation is the overall rise in the prices of goods or services in a market.
2. The Consumer Price Index (CPI) is the tool to measure the inflation rate (depicted as a percentage) and comes out with new reports on a monthly basis.
3. Typically, the Federal Reserve aims for an annual inflation rate of two percent.
4. The opposite of inflation is deflation, and this leads to a general decline in the overall prices of goods or services in a market.
What Causes Inflation?
While the root cause of inflation stems from the increase of the money supply in an economy, there are many factors that can contribute to the increasing money supply. The most notable, however, include:
1. The printing of more money by the Federal Reserve and distributing that money into the economy.
2. Lowering interest rates, allowing individuals and businesses to borrow more money, thus increasing the money supply.
3. Devaluing, or legally diminishing the value of, currency within an economy.
While these three actions contribute to the increase of money supply and thus, inflation, there are many other factors that can lead to increased inflation rates. Overall, it is important to understand these concepts to better comprehend inflation and why it is occurring, especially during times of increased inflation rates.
The Pros and Cons of Inflation
A very common misconception among the public is that inflation is always bad and will lead to harder economic times for all consumers. While this may be true in some instances, inflation can also lead to positive economic growth depending on how much inflation occurs and how rapidly the change may be. To better comprehend this idea, it is important to note both the pros and cons of inflation.
Pros: During times of increasing inflation, individuals and companies with tangible assets (the most common being any form of property) will see an increase in the value of their property, as inflation upwardly affects the prices of goods and services. With this spiked price, owners have the opportunity to sell their property for a scalable profit. Another benefit to inflation is that borrowers now have an easier time paying off any outstanding debt they may have. For example, an individual fresh out of college with thousands of dollars in student loans may want to see inflation rates increase, as each dollar they owe has now diminished in value. Overall, both of these examples prove that one’s economic status may benefit from a rise in inflation rates.
Cons: As inflation increases, businesses, workers, and consumers are at a higher risk of economic insecurity. For businesses, this insecurity stems from the inability to understand future economic behavior, as inflation can be difficult to predict in the long run. For workers and consumers, this insecurity comes from the inability to purchase goods and services within their price range. If wages do not increase, consumers can now only buy a limited number of products, seeing as their dollar is not as powerful as it was prior to the inflation spike. Adding on, inflation may only affect certain prices at first (i.e., food and energy prices) and others later, resulting in distorted and spiked prices in certain sectors even as inflation rates decline.
Overall, through this section, we have seen the ways in which inflation can both positively and negatively affect certain individuals and businesses.
Inflation in 2022
At the end of 2022, the change in the Consumer Price Index for all Urban Consumers during the year was 6.5 percent. Although this number represents a 0.1 percent decline from the previous month, it is still a historically high rate when compared to year-end inflation rates from previous years. As previously mentioned, the Federal Reserve’s year-over-year inflation target is 2 percent, so this year’s inflation rate demonstrates a significant increase. In fact, this year’s inflation rate is the highest the United States has seen since the early 1980s. The cause of this high inflation is not one single factor, but rather a combination of several factors. During the COVID-19 pandemic, the US government distributed stimulus checks and enhanced employee benefits in an effort to maintain the economy’s success despite global supply chain disruptions. However, once a vaccine became widely available and the economy bounced back, demand, fueled by government money, surpassed supply, leading to high inflation rates. Additionally, Russia’s invasion of Ukraine in the beginning of 2022 caused significant oil and gasoline restrictions through trade sanctions on Russia and limited exports of large grain harvests due to destroyed land from the war. These events caused prices in the food and energy sectors to skyrocket, and soon other sectors followed suit. While many economists have predictions about how long high inflation will continue, no one knows for sure how long it will last or how much worse it will become.
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