What you need to know about inflation

Vacuum sucking up money

*Editor’s Note: The “Views from NAU” blog series highlights the thoughts of different people affiliated with NAU, including faculty members sharing opinions or research in their areas of expertise. The views expressed reflect the authors’ own personal perspectives.

By Dennis Foster

Senior lecturer, The W. A. Franke College of Business

Dr. Dennis Foster is an economist who teaches courses on money, banking and macroeconomics.

Over the past few months, you likely have heard that inflation is at a 40-year high. At face value, we all know what that means—prices are rising, and unless our income keeps up with that, we will have a harder time trying to make ends meet.

As economists define it, inflation refers to a continuous rise in the average price level. It isn’t just a one-time rise in prices, nor is it the rise in just some prices. It is measured as the Consumer Price Index and is reported on monthly by the Bureau of Labor Statistics.

Why do we get inflation? It could, possibly, happen if the production of goods and services continuously falls when there is a fixed money supply. This is virtually impossible over any but the shortest of time frames. What we get instead is a situation where the amount of money grows faster than the production of goods and services, leading to higher prices overall.

It is important to recognize that going to war or passing trillion-dollar spending bills doesn’t cause inflation. Inflation only occurs when the money supply increases, perhaps as a matter of government policy to pay for that war or those spending bills. As Nobel economist Milton Friedman put it, “Inflation is always and everywhere a monetary phenomenon.”

Of course, this begs the question of who controls the money supply. Essentially, it boils down to our central bank, known as the Federal Reserve System. The Fed, as it is called, is charged with controlling the money supply, and ever since the recession of 2007-2008, its policymakers have acted to increase the money supply in dramatic fashion. We have dodged the inflation bullet for many years, but now it is catching up to us.

Where is inflation headed? Almost certainly up, based on how it is measured and reported. The numbers that are reported are for the “year-over-year” rate, which is 8.5 percent as of March. So, when the data comes in for April, the data from April 2021 will drop out of the equation. The monthly rates last April, May and June were relatively high, so for the next three months we may see inflation rise slowly or flatten out. But the rates for last July, August and September were unusually low, and it wouldn’t surprise me if the reported annual CPI by September of this year doesn’t cross over into the dreaded double-digit range.

Can you insulate yourself against inflation? The short answer is that you can try. If you can shift your wealth from low interest-earning financial assets to real assets, then you may at least cushion the blow.

But even that will not help for long. As bad as inflation is, the news gets worse. To fight against inflation, the Fed must act to decrease spending, which it does by raising interest rates. That always works, but that also means we get a recession as a consequence. And, as a general rule, the more serious the inflation, the more serious of a recession it will take to cure us of that problem.

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