So, What Is All This Talk About Inflation?

Inflation is one of those terms that we’ve definitely heard before, but may not know exactly what it means. Our parents may still have the memory of the 1970’s, when inflation was through the roof, but since then, it has been relatively tame. So why is it suddenly back in the conversation?

Inflation is the decline of purchasing power of a given currency over time. It is largely a natural process, and depending on your viewpoint, may be a good thing. For example, if you are a homeowner, inflation works in your favor. When you sell your house, it will have appreciated in value, in part due to inflation. For someone making a salary that does not increase annually, inflation is bad news.

For the general public, too much inflation has negative impacts. If it continues for too long, it can lead to a deceleration in economic growth. Economists theorize that sustained, troublesome inflation occurs when a nation’s money supply growth outpaces economic growth.

This is one of the reasons why we are hearing a lot of noise in the media about inflation at the moment. The Federal Reserve (the Fed), which largely controls the money supply through monetary policy, has been taking a very liberal approach during the pandemic. It has been keeping interest rates low, which entices people to borrow, adding to the money supply. They have also been buying Treasury bonds, which puts money into the hands of the people. Conversely, when the Fed takes a more conservative stance, it sells Treasury bonds and increases interest rates, which decreases the supply of money in the market. For example, the Fed has recently signaled that they are going to end their measure of buying bonds in response to the current growing economy post, and they are also going to begin to increase interest rates, potentially in Spring 2022.

We measure inflation by tracking the price levels of goods and services over time. The rise in general level of prices means that a unit of currency (i.e. the dollar) effectively buys less than it did in prior periods. Economists tend to use the Consumer Price Index (CPI) for these purposes.

The CPI is calculated by taking price changes for each item in a predetermined basket of goods and services which are of primary consumer needs, then averaging them based on their relative weight in the whole basket. The prices used are the retail prices, or what the average customer would pay. The Bureau of Labor Statistics reports the CPI monthly, which is another reason why this topic stays in the conversation.

So right now, we are experiencing extremely high inflation, which is causing all this ruckus in the news. But experts are conflicted over whether this is reason to sound the alarm.

The COVID-19 pandemic is and was an extremely abnormal event. It disrupted our entire U.S. economy and the global economy. Some experts say that inflation is just a natural event in the process of getting back to normal. Others say it is because of the policies put forth during the pandemic by the Trump and Biden administrations, as well as the Fed. As per usual, the answer probably lies somewhere in the middle.

For example, home prices are at record highs. But is this due to inflation, or is this due to an extreme surge in demand that cannot keep up with supply? During the pandemic, many people were cooped up inside their homes, and started to get a little bit annoyed. The house wasn’t big enough for the whole family to work from home, the neighborhood was too loud to be conducive to Zoom calls, people learned to hate your neighbors when cases spiked… so they moved out to the suburbs, or went house hunting for an upgrade. Or maybe the extra savings built up during the pandemic from a lack of recreational activities and student loan payments translated into a nice down payment on a house, and renting got tiring. These are all valid reasons that do, yes, tie into public policy, but do not have a whole lot to do with inflation. Housing prices will eventually come down again, as they always do, and all will be right with the world again.

For the last few months’ scary inflation numbers, used cars were the main culprit. And why is that? Global supply chains have been so disrupted because of the pandemic, and we are experiencing a major chip shortage (chips are the semiconductors that are important in modern cars that function almost like computers). Since new cars are in limited supply, their prices are up. If you’re in the market for a new car, a used car sounds very appealing right now.[1] You don’t have to wait for the chip to be in stock for your car; you can drive off the lot today! And of course, you need the car today, you have to take a road trip to see your now-vaccinated family!

If you’ve dined in a restaurant lately, you may have noticed that prices went up. But when we review the last year, it makes sense. Restaurants had to either close or operate at low occupancy levels, and they missed out on tourists. In some areas, like NYC, they had to take on the costs of building structures to create more outdoor seating, in addition to the PPE purchases. To make matters worse, we are experiencing a labor market shortage, so they are having to offer employees higher wages. While the higher wages may stay, eventually, the costs associated with PPE and COVID-19 structures will decrease, bringing down prices.

While there are clearly segments of our economy that are experiencing abnormal price increases, there are some sectors that we should be paying attention to in the future. For example, you may have noticed that your grocery bill has been increasing. With all the shipping and labor constraints companies have been facing, they are increasing prices to pay their bills. The question is whether consumers will get used to these new prices, creating a permanent increase in price.

The most important factor to bear in mind is that the CPI compares current prices against the previous year’s prices. While generally a fair measurement, last year was extremely abnormal, leading this year’s measurements to seem even more extreme.

So while inflation is important to pay attention to, and does have important implications for the economy, it may not be the big bad boogie man. For now, pay attention to your budgets and make sure you aren’t going too far over. Everything will work out in the end; it might just take some time to get back to normal.


[1] If you have a used car that you’re looking to sell, now is a fantastic time. You may even get a selling price that comes close to what you paid for the car, which is largely unheard of.