What is Inflation and How Does it Affect You?

Inflation is becoming the dominant conversation, but it is often misunderstood.

By Prince Addo

Photo Credit: TimvanHelsdingen

A tense scene unfolds at the Federal Reserve during the lock-down.

Inflation has been appearing more and more in the media and public consciousness, but many people misunderstand the meaning and implications of inflation on both the economy and on daily life. 

Inflation is a simple concept—prima facie—but its consequences are broad and span several aspects of life.

Politicians and the media like to talk about inflation as though it was thrust upon us like a flood or a plague, but inflation is brought on by monetary and fiscal policies that are well in “our” control. In the simplest form, inflation—as it relates to economics—is the increase of the supply of money and credit.

Although “the increase in the volume of money and credit” is the proper definition of inflation, it is often used to mean “the rise in prices.” However, this definition deflects from the real cause of inflation; price inflation is a consequence of real inflation.

When inflation occurs, people have more money to offer for goods. If the supply of goods does not increase—or does not increase enough—the price of goods will go up; and in turn, each individual dollar becomes less valuable because there are more dollars. 

Goods rise not because they’re scarcer than before, but because there are more dollars.

Prior to the Great Depression, America—along with most economies at that time—was on the gold standard. What the international gold standard provided was a stable currency. 

If a country tried to inflate their currency, gold flew out of the country, the country would have to stop inflating and the banks of said country would have to employ some monetary tools like raising interest rates to return the gold.

The gold standard had two negative consequences. Sometimes gold deflated currencies, which meant that those who were in debt had bigger debts and it didn’t give the government permission to inflate the currency at will to fund their various programs.

Because of this, and other reasons, the United States went off the gold standard in March 1933. 

What followed was a massive inflation of the currency, which culminated in a price inflation of 2,201.31%. This means that $100 in 1933 has the same value as $2,301.31 today.

Prices increase because the supply of money increases due mainly to government spending, but the government doesn’t have the power to print money. There’s a more indirect method in which the dollar is inflated. 

The government sells its bonds or other IOUs to banks; to pay for these bonds, the banks create “deposits” on their books which the government can withdraw from. The banks in turn may sell its government IOUs to the Federal Reserve bank, which pays for them by creating a deposit credit or printing more money.

One of the meaningful ways that price inflation is calculated is by taking a bunch of items, sometimes called a basket of goods, and tracking their prices over time. The U.S. Bureau of Statistics provides this data monthly under the name CPI(Consumer Price Index), which collects data from 6,000 housing units and 22,000 retail establishments in 75 urban areas across the country.

When inflation occurs, the economy experiences a large boost because consumers go out and purchase goods. This was clearly seen during the 2020 lock-down when revenues and equities were flying up in price; even used cars, which were strongly believed to always go down in price, started going up in price.

What follows is price inflation, which is the economy adjusting to the fact that there is more money in circulation, making it less valuable. This is what is occurring with the current CPI inflation rate at 6.4%.

We can learn about what might happen next from looking at what happened during the Great Inflation, which spanned the mid-1960s to mid-1980s. 

As prices were rising in the early 1980s, the Federal Reserve also increased interest rates. In late 1982, unemployment peaked at an all time high of 9.8%. 

Soon after, the inflation rate dropped sharply and so did interest rates; while unemployment dropped slowly.

Using this data, it could be concluded that there will be a recession by the end of 2023 with a rise in unemployment and a drop in economic activity. 

There has never been a time in U.S. history when recession ceased to exist; it is unavoidable and when it happens, like ripping off a band-aid, it will happen quickly.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.