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Inflation, Causes, and Impacts (Vol. 27)

Updated: May 31, 2023

analyticsbox | Nov 27, 2021


Inflation

This Hidden "Tax" Hurts Lower Income People the Most


The Federal Reserve is charged with, among other things, controlling inflation. The target for inflation has been 2%, until recently, that goal has been met in an expanding economy (until the pandemic). Now, however, things have changed and inflation has reared its ugly head and is so far running 5-6% with no signs of stopping any time soon.

Inflation has now increased to the point that it exceeds income growth, which means ‘real’ purchasing power has declined (you can buy less with the money you receive). Because lower income folks spend a higher proportion of their income on goods and services, the impact is greater on them (i.e. it is a regressive impact). No matter how you explain this, it is a REAL tax on everyone.

So what is causing this change? What can be done to change the course?

The most fundamental explanation is that the supply of money has grown faster than the supply of goods and services (see PowerPoint #5 for explanation of supply and demand curves). Inflation can occur in other ways - all of which have their own causes.

A primary cause which increases the money supply is government deficits, like the massive injection of Federal spending last spring. When the government spends more than it receives in taxes, it is putting more money into the economy than it takes out, which must be financed by borrowing. When the Fed is involved in the borrowing, this increases the money supply. When the output grows slower or declines, more money is then chasing fewer goods which will cause the prices to be bid up - so you get inflation.

So what has happened during the pandemic? Actually many things - reducing output, labor shortages causing reduced production, policy changes from the government, etc. All of these impact the relationship of money to supply. Some are hard to control, while others are very controllable.

First, a big factor is the shortage of labor which causes a decline in output. This reduced supply causes the price to rise (supply/demand curve).

Policy changes by the government are also a big impact. Gas prices are up over 60% in the last year, and heating oil this winter is projected to double in price. This can be traced to government policy on gas and oil production which has changed dramatically to lower production. We have gone from a net exporter to a net importer of oil. Lower supplies mean higher prices. Limited production accomplishes nothing, as oil and gas are fungible commodities (freely exchangeable or replaceable) and are traded worldwide. The price of oil is directly related to worldwide supply.

THE BOTTOM LINE

Inflation is a serious problem. If left unchecked, it can spiral out of control as has happened in many countries that tried ‘printing money’ to solve economic pain. That never works, it only makes matters worse.

Fundamental government fiscal policy (running large deficits) is a major factor in inflation and it is important for us to understand this and express our concerns to change the direction of these policies. Government interference with the market is another problem, such as the limits on oil and gas production. Limiting production does not limit demand! It only causes inflation in the short run, and it does not clean the environment, only a change in consumption patterns will do that.

Are you feeling the pinch? Of course you are! Everyone is! So what can you do about it?

UNDERSTAND ECONOMICS, THEN VOTE SMART.

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