RebelCapitalist: Financial Information for the Rest of Us

Inflation

May 17, 2011 | By: Mr_Blue | Tags: inflation

What is infation? Is it happening now? Why do current increases in food and gas prices suck?

Inflation is the continuous rise in prices over a period of time. If price levels increase 4% every month then that is inflation. If price levels increase 4% one month, 6% the next month and 8% in the following month then that is accelerating inflation. We can also have deflation where price levels actually decrease. Thing to remember is that inflation is a continuous increase in price levels.

There are is a lot of misinformation and myths circulating about inflation. We don’t have enough space or ability to keep you interested to address all of them so we will address two big points. First, price rises like we are seeing now in food and oil are NOT necessarily inflation but could become inflation if prices continue to rise over time. Second, there is myth that Fed is ‘printing money’ and causing inflation. This myth is based on a flawed theory called monetarism and BTW, the Fed isn’t printing money.

There are two sources of inflation: 1) demand side or cost-pull inflation and 2) supply side or cost-push inflation. Demand side or cost-pull inflation is when growth in economic output is outstripping the capacity of the economy so prices continue to rise as (aggregate) demand from output increases. Supply side or cost-push is when input prices, such as materials or labor, are increasing and producer in order to maintain a certain mark-up (or profit level) in prices starts to pass increase input prices to consumers/buyers. However, the issue is whether consumers/buyers will pay the higher prices or will demand just fall off.

What we are experiencing now is food and oil price shocks or supply side shocks driven in large part by speculation in futures markets. Again the issue is whether these price shocks will translate into continuous price level increases. For this to happen there has to ‘fuel for the fire.’ One source of such fuel would be increase wages/incomes but this isn’t happening. Without the fuel of increasing wages/incomes, it will be interesting to see if producers (and particularly retailers) will be able to pass-on input price increases or will they just have to absorb them (and lower or maintain their prices).

Despite this discussion of inflation the bottomline for working class families and families on fixed income is that the current increases in food and gas prices suck. They suck because wages/incomes haven’t keep up with the cost of living. There may not be ‘fuel for the fire’ of supply side inflation.

For more on inflation check out:

Modern monetary theory and inflation – Part 1
Modern monetary theory and inflation – Part 2

Good luck.