Infatuation With Inflation

Do you believe in ghosts? I do. I see one everywhere I go. The gas station, the grocery store, or even the hardware store. This phantom being shows up just before me, increases the prices of the goods or services I want, and I'm stuck paying the difference. Okay, enough with the corny Casper analogy - I'm talking about inflation. If you've purchased something recently, you've seen it too. Prices of consumer staples have jumped by rates not seen in decades. In fact, the most recent Consumer Price Index (which roughly tracks inflation) jumped to 7.5% year-over-year. This essentially means you're paying $107.50 in January 2022 for the same items that would have cost $100 in January 2021. This is the largest increase since February 1982 - just before I was born, so I can honestly claim the highest inflation in my lifetime! So is this a big deal? Should I care, or is it simply a fact of life? Let's get into the thorny pseudo-political economics of inflation.

They're infatuated with not making eye contact.

What Is Inflation?

Let's start with a basic question: what is inflation? Investopedia defines it as the reduced buying power of money over time, meaning a future dollar is less than a dollar today. Inflation can be caused by a few factors. Commonly, it's a correlation to how much money is circulating in the economy. In the U.S., monetary policy (by both political parties) has injected trillions of dollars into an already-hot economy in the last several years. Couple that with decreased goods/services output (supply chain, COVID impacts, Great Resignation, etc.), and you have a recipe for double-whammy inflation. It comes to simple supply and demand: more money is available to spend, and there are fewer goods and services to spend it on.

Now take it down an individual level and think how that impacts spending behavior. Take the example of buying a car. Say you want to buy a car, and find the car you want for $20,000 at the dealership. If you knew that the same car would cost $21,000 in a matter of months, and could afford to spend the money now, would you buy it today? Of course! Now, you have your car, but that's one less car available for sale. The manufacturer can't keep up with demand due to chip shortages or labor constraints and the lot doesn't get replenished. Do you think that dealership may increase its prices on the dwindling supply of cars? Inflation becomes a self-fulfilling prophecy until the drivers (of inflation, not the fictious cars from the example) are reversed.

Is Inflation Bad Or Good?

Inflation is definitely a mixed bag. Let's stick with the negative to start. First, when things cost more, it's a tax on everyone. While some may be able to absorb the hit easily, those on a tight budget can't absorb increases. Now, if everything goes up equally - including wages, it's somewhat of a wash. But let's be real - you're likely not getting a 7.5% wage increase tied to CPI. Additionally, as mentioned above, it becomes a tailspin. Economies that don't cool inflation can face hyperinflation, where money becomes almost worthless.

Now for the positive. Some inflation can be good for the economy because it drives spending. The multiplier effect explains how spending in a free-market economy helps drive production of goods and services. Money is only truly valuable when put to use, so people having the impetus to drop some cash on a dinner out or new clothes helps fuel the economy. The opposite of inflation - deflation - sucks that money back into consumers' pockets and kills cash flow. A healthy economy needs a small amount of inflation at all times.

Should You Care?

All this said, does inflation really matter to you? Absolutely! Inflation does impact your personal finances and could even impact your workplace. However, a low-to-moderate level of inflation is a normal, if not necessary, part of a good economy. Spending keeps money moving, which generates jobs, bolsters companies, and creates goods and services we need and want.

The key is tempering inflation over time. People much smarter than me in the Federal Reserve are constantly monitoring inflation and will take action accordingly to balance rising inflation against triggering a recession. Many in the Fed - after seeing January's CPI report - are calling for faster rate hikes to tame the price increases. These actions will help cool spending and borrowing, and hopefully bring the inflation down to a more reasonable level.

I apologize for slacking on the regular Dough-Nuts schedule, it's been a hectic time. Besides the normal hecticity (not a word, but it should be) of fathering two small children while my wife and I work, we are in the process of moving and I'm looking at career options. We are also in the midst of our investment property renovation - something I will cover in a future blog. With all this going on, I come here as an outlet to keep me happy and motivated through challenging times. I was amazed to see - without adding new content or promoting the blog - traffic continued to flow through the site! Hopefully you continue to find it helpful and thank you for your patronage. Talk to you again soon!