Americans get a refresher on inflation with every refill or trip to Walmart, but an entire generation has come of age with no awareness or experience of the long-term inflation. And since we didn’t have to deal with the phenomenon, thinking about why it happens and how to lick it may not have been high on the priority list until last year. Today we’re going to take a deeper look at the causes of inflation and the confluence of events that brought us to where we are today.
The textbook definition of inflation is the general increase in the price of living over a period of time. A more common and intuitive definition is the loss of purchasing power because a dollar doesn’t go as far as it used to. It is notoriously difficult to predict accurately, as shown by the outbreak of the disease, but it is necessary to attack it vigorously when it is confirmed.
Inflation can be caused by too much money in the system compared to economic activity. The Federal Reserve is charged with analyzing the money supply to support the demand for dollars, measured by the speed or number of dollars circulating in the economy during the year. As the economy expands rapidly, dollars change hands frequently, requiring the Fed to pump more dollars into the system (increase the money supply). Too much dollar relative to the velocity or demand for dollars can lead to inflation.
It should be noted that control of the money supply was the primary Fed tool in the 1970s and 1980s but was replaced by the interest rate target that we hear about today. With the explosion of electronic and virtual transactions, managing and even defining “money supply” has become difficult, but the concept of cheap money as a cause of inflation remains valid.
Another source of price instability is called “demand inflation,” because the economy is expanding rapidly and the increase in demand for goods and services outstrips production capacity, raising the price. An increase in demand can often be seen in home prices during periods of booming home sales. As the number of buyers grows faster than the pool of sellers, home prices rise, sometimes quickly. Housing is a catalyst for the broader economy, as it accounts for a large portion of the CPI price index. The real estate market and car manufacturing are very important because they generate a lot of secondary economic activity in construction, sales, insurance, parts production and loans.
The third major cause of inflation is inflation, a supply-side shock to the equilibrium of supply and demand in which demand remains stable but is limited or the supply of goods or services is blocked. Inflation often occurs in response to natural disasters that damage production facilities or shortages caused by geopolitical forces. For readers of a certain era, the Arab oil crisis of 1973 is a classic example in which the oil-producing countries of the Middle East formed a cartel called OPEC and conspired to limit oil supplies to of the West, tripling fuel prices and forcing drivers to queue. at the gas station.
We can easily point to historical examples of inflation from these conditions. What stands out about the current instability is that it comes from the three conditions arising from external factors and the political response to the crisis.
Responding to the pandemic emergency, the Fed quickly increased the money supply by a third in an effort to revive the battered economy as the pace slowed. The unexpected rapid recovery from covid shutdowns has resulted in too many dollars chasing too few goods, one of the common causes of inflation. Of course, my view is enlightening, but the reaction at the time was informed by the possibility of a permanent depression in economic activity caused by the once-a-year health emergency.
In the mid-2020s, the risk of a severe and widespread recession is the main scenario as the world waits for an effective vaccine and lockdowns and social distancing are the only measures to stop the death toll from rising. . In that case, many workers were able to keep working remotely, as Congress and two presidents added more than 5 trillion dollars in direct spending to the economy. Struggling with money and staying at home, households have increased spending on everything from houses to cars to iPads. Hello demand drags inflation: a sudden and unexpected increase in consumer demand has fueled the inflationary fire.
Meanwhile, off the coast of California: 109 giant container ships waiting last January confirmed the unprecedented collapse of a supply chain that has been delayed in anticipation of a long recession. This supply constraint is a case study in inflation that is just beginning to subside. Witness the effects of triple inflation as a case study for the next generation of graduate students.
The good news is that we know how to beat inflation thanks to the lessons of the 1980s. The bad news is that the medicine tastes bitter and the red-hot job and housing markets will have to cool, but the economy will recover. sick over time.
Christopher A. Hopkins is a chartered financial analyst and co-founder of Apogee Wealth Advisors.