Inflation. We’ve all seen it in the news and felt it at the grocery store over the past couple years or so. Let me explain what inflation is and how it affects you and your wallet.
What is Inflation?
Simply put, inflation is the cost of goods and services going up over time. Think about it like this. A Big Mac at McDonalds would cost you $2.39 in 2002. In 2023, however, it will cost you about $4.95. That is inflation.
The cost has gone up over time for a particular product.
Some amount of inflation is actually a good thing for an economy. After all, you want to get cost of living raises each year right? You want the value of the stocks that you own to go up also. And you want to earn interest on your savings account. Some of that increase in value is due to inflation.
However, as we all have seen at the grocery store, the gas station, and pretty much anywhere else we shop, inflation has become quite painful for the regular person.
What Causes Inflation?
I will not get too technical here because this is not an economics textbook. But there are five main causes of inflation.
Demand-Pull
This is the type of inflation that we saw during the heart of the pandemic. Demand-pull is the most common cause of inflation. This is when there is simply more demand for a product (or products) than there is supply.
Think about someone trying to get an Uber when all of the bars close downtown. All of the people leave the bar at the same time and most of them are trying to get a ride.
What does uber do? They raise their prices.
That is because there is more demand than supply. There are 100 people requesting rides and only 8 drivers. While an hour before there were 15 people requesting rides for the same 8 drivers.
That’s why you will pay a lot more for an Uber during busy times than when it is not so busy.
Cost-Push
This is the cause for inflation when input costs rise for a particular product.
Think about it like this. If you want a carpenter to build a deck on your house. You get a quote and the cost for that carpenter to build the deck is $1,000.
Later you decide not to build it right now but instead decide to wait until next year.
You contact the same carpenter but now he tells you that the cost is $1,200. The reason for the increase is because the cost of lumber has gone up.
This is cost-push inflation.
Increased Money Supply
The third main culprit for inflation is increased money supply. This is the main driver for the high inflation that we have now (although the real reason is a combination of all of these).
Increasing the money supply can be done through fiscal policy (set by lawmakers) and/or monetary policy (set by the Federal Reserve and/or other central banks).
The main way that the money supply can be increased is by the Federal Reserve or other central banks cutting interest rates. And they have done this for the past 15 years or so (until 2023 when they began to raise them again to combat inflation).
The Fed can also increase the money supply by decreasing the required reserves for banks. Although this does not affect the money supply as much as decreasing interest rates.
As far as fiscal policy is concerned, the lawmakers can increase the money supply (and thus increase inflation) by lowering taxes, providing stimulus money and tax incentives, or the forgiveness of debt. And all of these have been done in some capacity over the past few years.
Devaluation
Devaluation is the reduction of the value of a currency in relation to other currency (this means the exchange rate).
Think of Venezuela. Venezuela has EXTREME inflation right now. When their currency inflates more and more, it takes more Venezuelan Bolivars (their currency) to equal one U.S. Dollar, their currency is devalued.
Rising Wages
Rising wages are the last cause of inflation.
All businesses have costs. One of those costs is that of wages paid to workers. When the workers get paid more money, then the company has to raise the cost of the goods or services that they are producing in order to maintain a profit.
Think about it like this. If all Ford workers were suddenly given a 30% increase in pay, the cost of the next Ford vehicle that you buy will go up to reflect that.
Final Thoughts
This article isn’t political. This is simply factual. We are dealing with high inflation and although politicians want to point the finger at the person on the other side of the aisle, the fact of the matter is, both parties are at fault.
We have had decades of government overspending, unusually low taxes, and historically low interest rates. High inflation has been coming for years now. And now here we are.
But I will do everything I can to give you the tools to combat inflation, stretch your dollars, and get organized with your money so that you can get ahead financially.
I am here for you!
You can do this!
Until next time!
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