Over the past couple of months, the term “inflation” has been widely used. Inflation and its rising concern are hot topics for news media, including financial programming, and water cooler chatter, for those folks back to the workplace routine. Inflation fears have slipped into the U.S. stock market, causing major averages, such as the S&P 500, to experience even more volatility as investors begin to absorb higher-than-expected inflation data. According to reports from the Labor Department, April saw inflation rise at its fastest rate since 2008, with consumer prices surging 4.2%. Although this significant rise in inflation has intimidated investors and has caused some volatility in the stock market, we must remember that prices were somewhat depressed in 2020 due to the COVID-19 pandemic and lack of economic activity. Sensationalized inflation promotes uneasiness, but inflation expectations above the 2.5% level are historically normal for a recovery period, the state in which we find ourselves currently.
Let’s get back to basics – what is inflation? Defined as a measure of the rate of rising prices of goods and services in an economy, inflation can occur in nearly any product or service, including housing, food, medical care, automobiles, jewelry, you name it. To illustrate, imagine making a usual stop at the grocery store in 1971. You have $100 and you buy eggs, milk, bread and a host of other items for your family. The total cost of your shop is $25, leaving you with $75 to spend freely on other goods, products or services. Fast forward to 2021, finding yourself once again with $100 on your venture to the grocery store. You purchase eggs, milk, bread and the same items you bought back in 1971. This time around, your shop cost $100. The total price of those same groceries is 400% more expensive in the year 2021 than in 1971 and you have nothing left over to purchase anything else. That’s inflation in action.
In the graphic below you’ll see how inflation has impacted the price of a cup of coffee.
Seemingly incremental, a consumer may be gobsmacked to know that he or she pays six times as much for a cup of coffee now than in 1970.
Inflation can be classified into three major types: Demand-Pull Inflation, Cost-Push Inflation and Built-In Inflation.
Demand-Pull Inflation arises when the demand for goods or services is higher when compared to how much of the product is produced. Put simply, when demand is higher than supply, the price of the product will appreciate.
Cost-Push Inflation occurs when the cost of production increases, therefore increasing the prices of labor, raw material, etc., and further increasing the price of the product, good or service.
Built-In Inflation is the expectation that there will be inflation in the future. Prices rise due to higher wages to afford higher cost of living. Higher wages, therefore, result in increased cost of production and in turn impact product pricing.
(Source: Investopedia https://www.investopedia.com/terms/i/inflation.asp)
Although spending more money for the same products makes most of us grit our teeth and widens our eyes, inflation can also be positive, when controlled and mild. For example, inflation makes consumers expect prices to continue to rise. Because of this, some consumers may be inclined to purchase more now rather than pay more later, and this may increase demand in the short-term. Because of this increase, stores will sell more product, forcing manufacturers to produce more product and materials andhire more workers to keep up with the demand. This positive inflation bolsters economic growth.
Furthermore, inflation, when viewed as a positive, can remove the concern for deflation. You guessed it, deflation is the opposite of inflation, and occurs when prices fall. In times of deflation, consumers are willing to “wait and see” if prices of products they wish to purchase will dip, causing stores to sell less, and manufacturers to produce less and eventually reduce their workforces. If this cycle of increased unemployment, decreased consumer spending, lower wages, and falling company revenues continues, deflation could hinder economic growth for a period of time.
To combat inflation and deflation, a country’s monetary authority, or central bank, is tasked to measure the money supply and manage inflation to keep the economy running smoothly and efficiently. The Fed has stated many times that they are targeting 2% inflation through 2023. The Fed’s main goals are to help curb or stabilize inflation, moderate long-term interest rates, keep prices steady and keep the unemployment rate low.
As noted, inflation has caused some apprehension of late, but Private Capital Group remains committed to guiding you and your family through this recent market volatility. PCG is thankful to have you as our client, and we will continue to work tirelessly to ensure you and your family have the financial peace of mind you deserve.
As always, we wish you health, happiness and safety, and as we enjoy the unofficial start to the summer with the upcoming celebration of Memorial Day, please remember those who served and died in our Armed Forces, helping to protect our great country, and gift it with the freedoms with which we are privileged.
Enjoy your weekend!