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The Nature and Cause of Inflation (Vol. 129)

Understanding it is easy; Fixing it is hard

Econ 101: Inflation occurs when the money supply increases faster than the increased output of goods and services.


We are focusing on general inflation, most commonly measured by CPI, consumer price index, not a price change for a particular item; these are always moving up and down with changes in supply and demand for an item.


If you have had any economics or understand supply and demand curves, this is simple stuff. Even if you haven't studied this, it is intuitively obvious. When there is more demand for something than there is supply at a given price, there is a shortage at that price and the price will get bid up. As the price rises, the demand falls to the point where it matches supply, the shortage is gone and you have equilibrium. The price where equilibrium occurs is the market price at that moment.


An example of ‘spot’ price change is when millions of chickens died from avian flu last year. This caused a shortage of eggs and the price doubled. That is a classic example of changes in the supply/demand curve and the price rises as a result of a shortage. Over time more chickens were raised and the price returned to ‘normal’.


The same action occurs in the overall economy, macroeconomics. But we are talking about all commodities in general, not a specific commodity. Too much money chasing too few goods means there is a shortage of goods at the current price. With the extra money, they will demand more goods, but there are no more goods, thus, a shortage. So the prices will rise until it reaches a point where demand falls until demand matches supply, at a higher price. We call that inflation when it occurs across the economy.


To illustrate in an extreme example... say we are at equilibrium today. Overnight the money supply doubles. We have more money and demand more goods and services, but there aren’t any more. We have a shortage. We would compete for the available supply by offering more money for the products. Over time, in our example, the prices would double and supply and demand would be back in equilibrium but at twice the price. Inflation. Our standard of living has not changed. We have the same goods and services as before, just at double the price.


So what just happened here in America? Why inflation now. I am sure you have already figured it out, we grew the money supply too fast in recent years and, with a delayed reaction, eureka; we have inflation.


In Facts, No Spin #39, Do Federal Deficits Cause Inflation?, I analyze the growth in money supply and inflation results over the last 12 years. Starting in 2020 and continuing until mid 2022, the government started ‘printing money’ faster to pay for the enormous deficits. The money supply grew 26% in 2021 and with delayed reaction inflation peaked at 9%. In the last year, money supply has actually decreased by about 5% and inflation is falling.



BOTTOM LINE


This country has had enormous and growing deficits since 2001, the last year we had a balanced budget, actually it was a surplus that year. We can finance the deficit by either borrowing from the public (which is not printing money and not inflationary), or by borrowing from the Federal Reserve (which is printing money). When we ‘printed’ modest amounts of money in relation to growth in output, there was modest inflation. In 2020, we started printing money much faster, and inflation began to heat up.


The root cause of our problem is fiscal deficits where we spend well in excess of our revenue. Bad fiscal policy (big deficits), compounded with bad monetary policy (printing too much money) has resulted in inflation (and extraordinary government spending just adds to aggregate demand, pushing inflation as well).


The cure: Get our fiscal policy in order, then we do not have big deficits to finance. This is needed for many reasons, as we are headed for economic disaster on the current trajectory (see Facts, No Spin #126, Yes, Virginia, the Debt Crisis is Real).


Fixing fiscal policy is up to us. The politicians will not do this without public support, SO, DON’T JUST SIT THERE - DO SOMETHING. Contact your representatives, we have made it easy - go to our website and Contact Congress. Invest 1 minute to do your duty as a citizen.


LEARN ECONOMICS, THEN VOTE SMART

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