Biden's Inflation Problem?Public Policy

Biden’s Inflation Problem?


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The annual inflation rate in the US edged up to a 13-year high of 5.4% in September of 2021 from 5.3% in August and above market expectations of 5.3%. Main upward pressure came from cost of shelter (3.2% vs 2.8% in August); food (4.6% vs 3.7%, the highest since December of 2011), namely food at home (4.5% vs 3%); new vehicles (8.7% vs 7.6%); and energy (24.8% vs 25%). On the other hand, prices eased for used cars and trucks (24.4% percent vs 31.9%); transportation services (4.4% vs 4.6%); apparel (3.4% vs 4.2%); and medical care services (0.9% vs 1%). On a monthly basis, consumer prices advanced 0.4%, above forecasts of 0.3%, with the indexes for food and shelter contributing more than half of the monthly increase. The core index which excludes food and energy went up 0.2% month over month and 4% year over year, the same as in August and in line with forecasts.

|Source: U.S. Bureau of Labor Statistics|

What is Inflation?

Investopedia | investopedia.com

Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.

Inflation can be contrasted with deflation, which occurs when the purchasing power of money increases and prices decline.

Key Takeaways

  • Inflation is the rate at which the value of a currency is falling and, consequently, the general level of prices for goods and services is rising.
  • Inflation is sometimes classified into three types: Demand-Pull inflation, Cost-Push inflation, and Built-In inflation.
  • The most commonly used inflation indexes are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI).
  • Inflation can be viewed positively or negatively depending on the individual viewpoint and rate of change.
  • Those with tangible assets, like property or stocked commodities, may like to see some inflation as that raises the value of their assets.

Understanding Inflation

While it is easy to measure the price changes of individual products over time, human needs extend beyond one or two such products. Individuals need a big and diversified set of products as well as a host of services for living a comfortable life. They include commodities like food grains, metal, fuel, utilities like electricity and transportation, and services like healthcare, entertainment, and labor.

Inflation aims to measure the overall impact of price changes for a diversified set of products and services, and allows for a single value representation of the increase in the price level of goods and services in an economy over a period of time.

As a currency loses value, prices rise and it buys fewer goods and services. This loss of purchasing power impacts the general cost of living for the common public which ultimately leads to a deceleration in economic growth. The consensus view among economists is that sustained inflation occurs when a nation’s money supply growth outpaces economic growth.

To combat this, a country’s appropriate monetary authority, like the central bank, then takes the necessary measures to manage the supply of money and credit to keep inflation within permissible limits and keep the economy running smoothly.

Theoretically, monetarism is a popular theory that explains the relation between inflation and the money supply of an economy. For example, following the Spanish conquest of the Aztec and Inca empires, massive amounts of gold and especially silver flowed into the Spanish and other European economies. Since the money supply had rapidly increased, the value of money fell, contributing to rapidly rising prices.

Inflation is measured in a variety of ways depending upon the types of goods and services considered and is the opposite of deflation which indicates a general decline occurring in prices for goods and services when the inflation rate falls below 0%.

Causes of Inflation

An increase in the supply of money is the root of inflation, though this can play out through different mechanisms in the economy. Money supply can be increased by the monetary authorities either by printing and giving away more money to the individuals, by legally devaluing (reducing the value of) the legal tender currency, more (most commonly) by loaning new money into existence as reserve account credits through the banking system by purchasing government bonds from banks on the secondary market.

In all such cases of money supply increase, the money loses its purchasing power. The mechanisms of how this drives inflation can be classified into three types: demand-pull inflationcost-push inflation, and built-in inflation.

Demand-Pull Effect

Demand-pull inflation occurs when an increase in the supply of money and credit stimulates overall demand for goods and services in an economy to increase more rapidly than the economy’s production capacity. This increases demand and leads to price rises.

With more money available to individuals, positive consumer sentiment leads to higher spending, and this increased demand pulls prices higher. It creates a demand-supply gap with higher demand and less flexible supply, which results in higher prices.

Cost-Push Effect

Cost-push inflation is a result of the increase in prices working through the production process inputs. When additions to the supply of money and credit are channeled into a commodity or other asset markets and especially when this is accompanied by a negative economic shock to the supply of key commodities, costs for all kinds of intermediate goods rise.

These developments lead to higher costs for the finished product or service and work their way into rising consumer prices. For instance, when the expansion of the money supply creates a speculative boom in oil prices the cost of energy of all sorts of uses can rise and contribute to rising consumer prices, which is reflected in various measures of inflation.

Built-in Inflation

Built-in inflation is related to adaptive expectations, the idea that people expect current inflation rates to continue in the future. As the price of goods and services rises, workers and others come to expect that they will continue to rise in the future at a similar rate and demand more costs or wages to maintain their standard of living. Their increased wages result in a higher cost of goods and services, and this wage-price spiral continues as one factor induces the other and vice-versa.


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