Understanding Inflation: The Law of Supply and Demand |
After celebrating Thanksgiving, many of us have experienced inflation.
According to the Farm Bureau, if you are hosting friends and family, you paid an average of 14% more this year for our holiday meal food. While each item in the typical Thanksgiving feast was more expensive, the 24% increase in the cost of the Thanksgiving turkey was the largest.
Even if you didn’t organize the turkey’s meal of the day, you probably weren’t immune to inflation. If you drive for family while on vacation, according to the Bureau of Labor Statistics, you’ve probably paid almost 50% more for gasoline to get there. Overall, the BLS reported an annual inflation rate, as measured by the Consumer Price Index, of 6.2%.
Unfortunately, wages are not keeping pace with these higher costs, with the BLS reporting an actual (inflation-adjusted) drop in average hourly earnings of 1.6% over the past year. Put simply, the average hourly worker can only afford to buy 98.4% of what they could a year ago.
Inflation is the result of having too much money available in our economy to chase after too little goods available for purchase. It is the fundamental law of supply and demand.
On the supply side, inefficiently managed standby ports, an overall shortage of available workers and a host of other factors have resulted in a decrease in the supply of many items in demand by consumers.
A shortage of computer chips, for example, led to a decrease in the number of new vehicles available for purchase, leading to a 9.8% increase in the price of new vehicles and a 26.4% increase in the price of new vehicles. occasion in the past. year.
The demand side of inflation is largely influenced by the amount of dollars available in the economy. These available dollars are called the money supply, which is regulated by the policies of the Federal Reserve Bank.
Demand is also influenced by federal government fiscal policies through the use of deficit spending as a means of economic stimulus. With the passage of three separate COVID relief bills costing more than $ 2 trillion, our federal government recorded a deficit of $ 3.1 trillion in 2020.
With the continued costs of COVID and the recent passage of a major infrastructure bill, we are currently on track to record a $ 3 trillion deficit in 2021.
The federal government must borrow money to finance these deficits by issuing new debt. As long as there is sufficient demand for this debt from investors, dollars in the existing money supply will be used to buy this debt.
With our national debt recorded, investor demand is not sufficient to cover the new debt, forcing the Federal Reserve to step in and buy that debt. The Federal Reserve buys this debt by creating (printing) new money, thereby increasing the overall money supply in the economy.
In the last year alone, for example, the money supply increased by nearly $ 2.6 trillion, an increase of 14.7% since October 2020. This sharp increase has left us with more money to research less goods.
Individually, there is little we can do to tackle the root causes of inflation. But now is a good time to refinance your mortgage or buy your new home, because with high inflation, interest rates are expected to rise in the near future.
Plus, if you don’t have a personal or family budget yet, now is the time to sit down and take a serious look at your finances to prepare for the year ahead.
James Nelson is Associate Professor in the Department of Finance, College of Business, East Carolina University. Your financial health is provided by the college.