“Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.” – Sam Ewing
We all feel it today! Prices are not just up for a haircut, but at the grocery store, and at the gas pump; it is everywhere. Even my waistline is feeling inflated. But seriously, after years of abnormally low inflation, we are now feeling the effects throughout our economy. So, what causes inflation and is there a way to take advantage of it?
While Sam’s explanation was spot on, let’s look at the official definition of inflation:
Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country.
The most well-known indicator of inflation is the Consumer Price Index (CPI), which measures the percentage change in the price of a basket of goods and services consumed by households.
Ok, now that we know what the definition of inflation is, let drill down and see what causes inflation. We’ve broken it down into 5 types:
- Demand Pull – basically demand for a product or services outweighs the supply of that product. Sporting event is sold out that you want to attend. Ticket face value $100…current price $200. You now must pay a premium to see the game. Pulled that money right out of your wallet…didn’t it.
- Cost push – this is when prices of the raw materials and wages to produce a product go up. Since the demand for goods hasn’t changed, the price increases from production are passed onto consumers creating cost-push inflation.
- Increased money supply – money supply is the total amount of money in circulation. If it increases too much, then there will be too many dollars chasing the purchase of too few goods. An example would be when the Federal Reserve purchases securities (bonds) in the open market. (What they have been doing over the past few years).
- Rising Wages – When workers receive a wage hike, they demand more goods and services and this, in turn, causes prices to rise. The wage increase effectively increases general business expenses that are passed on to the consumer as higher prices. We have that issue now. I needed that spike back in the day when I bailed hay for my uncle at $1.40/hr. Something got bailed that day, but it wasn’t only the hay.
- Policies and regulations – these could be fiscal policies (handing out money, spending) or restrictive regulations such as rent stabilization (a form of insurance for tenants against unreasonable rent increases) or price fixing (setting the price of a product rather than allowing it to be determined by free-market forces). Government is truly the only organization that can fold a dollar bill in half, call it two dollars and then spend it.
The Last Word
For the last several years inflation has run at a rate of < 1%. We’ve been spoiled from a borrowing and cost of living standpoint. But some inflation can be good such as a modest increase in wages and a decent return on your savings. Too much too fast on the other hand and well, welcome to our current situation. But there are opportunities created in such chaos. Let’s explore one. Check out https://www.treasurydirect.gov/savings-bonds/i-bonds/ these I bonds currently yield 9.62% ( rate changes every 6 months) Do your homework, understand what you are buying and maybe you can pull back some of that money from Mr. Inflation.