A hike in commodity prices, ambitious government spending during the COVID-19 pandemic, and the subsequent economic crash can only mean one thing: inflation is inevitable.
In this blog, we’re going to answer the key questions we’re all looking for answers to – what is inflation, why is everyone talking about it, and is there cause for concern?
Keep reading to find out more!
What Is Inflation?
Inflation might sound like a complex economic term, but it’s pretty simple once you break it down. The word refers to a general increase in the price of goods and services, meaning each dollar in your pocket has less and less purchasing power over time.
It’s normal for economies to experience some level of inflation each year, usually impacted by current affairs or significant global events such as the COVID-19 pandemic. The price of coffee, for example, rises steadily, and as a result, we naturally expect that to continue.
Most economists claim that some inflation is necessary, theoretically boosting productivity. If an economy isn’t already using all of its labor and resources to produce as much as possible, inflation can push businesses and people to work harder. That’s because more money spurs more buying, and more buying stimulates more production.
Should I Be Worried About Rising Inflation?
The Federal Reserve, responsible for US financial policy, has a target annual inflation rate that comes in at around 2%, anything above this can cause concern.
High inflation, which causes a rapid devaluation of currency, creates economic problems for households and markets, including:
❖ A drop in real wages. When prices rise more quickly than wages, real incomes drop.
❖ Rising inequality. Poor households with few tangible assets, are more vulnerable than affluent households that own property and other inflation-resistant investments.
❖ Economic uncertainty. When businesses don’t know what future costs will be, they make fewer capital investments, slowing down the economy.
❖ Less competitive domestic goods. Runaway inflation can cause the nation’s consumers to buy more imported goods and foreign consumers to buy fewer of the country’s exports.
❖ Rising unemployment. As prices increase, businesses may reduce costs by employing fewer people.
The Federal Reserve often tries to curb inflation by raising interest rates, but that comes with its own economic consequences. Namely, the cost of borrowing rises, leaving consumers with less money to spend. In return, businesses lower prices to attract buyers. Though this can slow inflation, a drop in consumer spending can also slow down the economy, demonstrating one of the adverse effects of runaway inflation.
The Current Inflation Situation
As the US economy reopens to full capacity post-COVID, inflation has shot up. Economists are currently disagreeing on whether that’s cause for alarm, partly because the last few decades have challenged the conventional understanding of inflation.
Low unemployment rates have historically been associated with high inflation, although this link deteriorated in the late 1980s. Inflation remained stable after the Great Recession, even against fast job gains. While some economists see big government spending, low-interest rates, and excessive consumer spending as a recipe for disaster, others are less concerned.
Here are some of the reasons they give:
❖ Stable inflation over the last few decades may signal that central banks have mastered monetary policy, making it less likely for inflation to get out of control.
❖ The current spike in inflation is set to be a temporary issue as the economy snaps back to normal levels of activity.
❖ Some argue that even if high inflation increases economic risk, the risk of keeping so many unemployed and without financial relief is far greater.
Inflation is a fact of modern economic life. It can be a good thing when it’s kept below a manageable threshold. While we can’t predict what the future will look like as countries across the globe begin to reopen after COVID-19, we can expect that inflation will remain a hot topic of discussion.
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