Understanding the Fundamentals of Inflation
Having an idea about what causes inflation can be vital to your business and finances. Whether you’re in the market for a new business or are just considering an investment, knowing the fundamentals of inflation can be vital to making the right choice.
Demand-pull inflation
Often called a demand shock, demand-pull inflation refers to an increase in prices. It occurs when a growing economy causes the demand for goods and services to exceed the productive capacity. This is usually due to strong consumer demand but may also result from other factors.
Demand-pull inflation can be seen in the economy during a recession. For example, during the Great Recession, the real estate market collapsed. The increased demand for homes drove up the price of mortgage-backed securities. The higher prices caused a bubble. The mortgages were packaged into mortgage-backed securities, which were then sold to investors.
Demand-pull inflation is sometimes good. In some cases, it boosts economic growth and prosperity. However, in other cases, it reduces living standards.
Some examples of demand-pull inflation in the United States include the price of surgical masks and hand sanitizer. A few other examples of this type of inflation include the rise in the price of Nintendo gaming systems in the wake of the worldwide pandemic.
Cost-push inflation, on the other hand, is not as prevalent. This is because it results from a material shortage or a geopolitical shock. It can result from increased per-unit production costs and labor or raw materials.
Inflation expectations
Several factors influence inflation expectations: consumer spending, communications from the Fed, and market-based measures. For instance, the difference between a security’s nominal and real price is a measure of a market participant’s expectations of inflation. Inflation expectations are also dependent on short-term interest rates.
Inflation expectations have risen significantly in the past year. They reached their highest point in over 40 years in the summer of 2022. However, these predictions have yet to be very reliable during periods of stable inflation.
During the booming economy of the late 1990s, short-term expectations were a poor predictor of inflation. In contrast, long-term expectations remained solidly grounded.
Although there is no single best way to measure inflation, the Fed’s Survey of Consumer Expectations has a lot of useful data to offer. Specifically, it includes a rotating panel of around 1,300 household heads. The survey asks respondents to make estimates of how prices will change over the next five to ten years.
Other measurable indicators include surveys of businesses and consumers. These are used to determine the level of inflation expectations that individuals may have.
Another interesting measure is the TBI curve. This curve is a unique measure of market-based inflation expectations. This curve covers 175 months from July 2003 to January 2018.
This graph outlines the TBI curve and the CPI-U. The curve is made up of a series of nominal and real yield curves. The difference between the TBI and CPI-U rates is a good measure of how well participants’ expectations match reality.
Stagflation
During stagflation, price pressures can become so intense that they push consumers to pull back on purchases. As a result, unemployment rises. This can have damaging effects on the economy. It is also difficult to control.
Stagflation can happen in different forms, depending on the country and the specific conditions. The 1970s was a particularly bad period for stagflation. In fact, it was so severe that the global economy went into recession. The crisis was a result of monetary policy, with the US and other countries aggressively hiking interest rates.
The 1970s were marked by a sharp rise in inflation, unemployment, and a recession. The Nixon administration imposed a number of policies, including price and wage controls, to fight inflation.
Another cause of stagflation is supply disruptions. In these cases, an industry may lose jobs due to labor or raw materials shortages. In addition, businesses may be unable to afford higher wages and lower savings.
Some economists argue that the rising price of energy and food causes stagflation. Others claim that the high inflation of the 1970s was a consequence of tight business regulations.
Some believe that stagflation will re-emerge around the world. One of the reasons is the energy crisis in China. The situation has hit the price of oil and gas. It has also led to supply shortages in some industries, such as the semiconductor chip industry.
Conclusion
Currently, inflation concerns are drawing global attention. However, United States Secretary of the Treasury Janet Yellen has reported that she anticipates lower inflation rates, possibly by the end of 2023. She further stated that a recession, while possible, is not something she sees in the near future. While some disagree, her opinion brings us optimism for the coming year as we all hope for a stable and healthy global economy.
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