Why is Everyone so Concerned About Inflation?

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Until the previous year, the concept of economic inflation was nothing more than a good story the older generation would hold over everyone else’s head. Back in the early ‘80s, it wasn’t inflation that made people very uncomfortable with managing their finances, it was the Fed’s policies to combat inflation that forever changed an entire generation’s view of debt. Those people in America who held mortgages or loans during the early ‘80s are not nearly as comfortable with holding debt as most of the generations that have come after them. We cannot blame them for being so averse to holding loans unless completely necessary; mortgage rates topped out at 18.63% in October of 1981 but stayed at almost 10% through the end of 1989.

To understand why controlling inflation is of utmost importance, we first need to understand what it is. In economic terms, inflation is the rate of increase of prices for things we purchase over a given period of time. We can view this both positively and negatively. From a positive position, all things that we own – home, investments and cars – increase in value but at the same time, our ability to purchase things with each dollar decreases. Discussing the causes of inflation can become pretty complicated and over the past year, the subject has been debated quite a bit because it seems to be caused by a combination of factors. Most of the inflation issues seem to stem from COVID and the effect it had on our economy. A period of increased costs for production due to supply chain issues and salary increases has made it much more expensive to make things post-covid vs pre-covid. We also saw a large increase in demand coming out of the pandemic, when people had additional savings and an increased appetite for spending due to lockdowns. In order to help put money into the economy to help businesses get through the COVID slowdown, we also saw a staggering increase in money supply in the form of multiple stimulus packages. No one truly knows which of these factors has had the most effect on us reaching our current, almost 40-year high inflation numbers; but it is safe to say that inflation does not seem to not be going away as quickly as everyone hoped it would.

So, how is inflation controlled and by whom? The way to reduce inflation is by reducing the purchasing power of the people – this can be done by either the Federal Reserve or to a lesser extent, the U.S. government. Not to get too deep into the weeds, but the Fed can either raise or decrease rates to make borrowing more or less expensive, or they can increase monetary supply by buying or selling Treasury bills. The U.S. government can also increase taxes, giving taxpayers less disposable income. Any type of bill that claims to help decrease inflation could potentially do the exact opposite by significantly increasing monetary supply again.

Why is controlling inflation important? The U.S. is currently the world’s reserve currency, meaning that most countries do all of their trading with U.S. currency and most hold their cash in some type of U.S. currency or bond. If inflation were to spin out of control and our currency devalue vs the rest of the world, it could lead us down a path of no longer being the currency that the rest of the world wants to hold.

So, as we head into mid-term election season and are inundated with finger-pointing on both sides of who did what and who caused what, let us remember that going forward, there is only so much that either political party can do to control something as significant as inflation.

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