Inflation Explained

Amanda Luzzader

In this article, we’ll discuss what inflation is, how it works, whether it’s occurring in the United States, and how it affects ordinary Americans.

It'd be hard to deny that gas prices have increased a lot lately, and everyone knows that housing costs have skyrocketed in the past few years. It may seem like everything costs a little more now, even though you might not be getting paid more.

So, is this the inflation we keep hearing about?

In this article, we'll discuss what inflation is, how it works, whether it's occurring in the United States, and how it affects ordinary Americans.

What is Inflation?

The pricing of various goods and services increases and decreases all the time. Sometimes milk and eggs seem inexpensive, but other times their prices spike. The price of gas goes up when people want to travel (e.g., in the summer and around the holidays), and then it goes down afterward. Some prices rise gradually over time; others go up and down a lot.

Inflation as a measurement does not attempt to quantify or explain every up and down in the pricing of all goods and services. Instead, inflation is the rate at which a currency's buying power is declining. Inflation is also seen as a measure of the increase in the prices for everything in a theoretical "basket" of goods and services that consumers always need and want. And so, inflation can be said to be an ongoing index of the collective increases in (the "inflation" of) the costs of food, clothing, transportation, housing, raw materials, commodities (such as electricity), and even things like entertainment. It also measures how effectively these things can be provided to consumers and how much they cost to produce.

Simply put, inflation measures the decrease in the buying power of your money. When the cost of everything rises, your dollar buys less of anything. You're not earning any less money, but each dollar you earn is weaker than it used to be.

What Causes Inflation?

Generally speaking, inflation is the result of converging market forces. These are not limited to the following forces but generally involve (1) increases in the cost of labor and production, (2) an increase in demand for certain goods and services, and (3) an increase in the supply of currency.

These market forces are not adverse on their own, or when they are it is minor. However, when these forces converge and when they happen on a large scale, inflation can follow.

It doesn't take a professor in economics to recall that the United States is currently suffering acutely from items 1 and 2. The COVID-19 pandemic, supply-chain disruptions, and severe labor shortages have caused the costs of production and services to rise sharply. At the same time, the housing shortage and affordable housing crisis have caused demand for certain critical products and services (homes and construction) to surge. Inflation is one result.

What is the Rate of Inflation Now?

The U.S. Bureau of Labor Statistics (BLS) is a cabinet-level government agency that collects and reports data regarding the U.S. economy and labor market. Two key reports it generates are the  Consumer Price Index (CPI) and the Producer Price Index (PPI), which are used to determine when inflation is occurring and at what rates.

In January of 2022, the BLS reported that the CPI for all urban consumers had risen by 7.5 percent in the previous 12 months. This was the largest 12-month increase measured since June 1982.

Who Does Inflation Hurt the Most?

While a 2021 article published by Bloomberg asserts that the rich suffer during inflationary periods, it is of course those with lower incomes who suffer the most. Those with lower incomes not only spend a greater relative proportion of their income on necessities, but they also save and invest less, leaving them more vulnerable to scarcity.

Does Anyone Benefit from Inflation?

As with many economic dynamics, inflation hurts some people while helping others. Producers, manufacturers, and service providers may benefit because they can charge more for their goods and services, though this benefit can be easily offset by rising costs of materials and other costs. Inflation also benefits investors who hold on to assets that benefit from inflation (such as energy assets).

Inflation benefits borrowers because it enables them to pay back their debts with money that is worth less than it was when they borrowed it. Oddly, inflation can also have the effect of benefiting lenders because interest rates often rise in response to the greater demand for credit.

When Will the Current Period of Inflation End?

Inflation is a reaction by consumers and producers to market forces. Market forces are constantly changing. This gives cause for hope that once inflation sets in, it will eventually give way to new market forces and other influences.

In a recent article published by the Wall Street Journal, two experts gave their opinions on the current inflationary conditions.

Economist Paul Krugman's opinion is that "rising prices will get worse before they get better. There's still a lot of inflation in the pipeline." Krugman went on to express some optimism. He said the current inflationary situation is much less serious than it was four decades ago and that the Fed Chairman Paul Volcker will likely bring it under control without unduly damaging the overall economy.

The outlook of Economist Larry Summers, on the other hand, is less rosy. He said that the Fed's handling of the current situation "is likely to lead to stagflation, with . . . unemployment and inflation both averaging over 5 percent over the next few years---and ultimately to a major recession."

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