Inflation is a rise in the aggregate prices of goods and services across the economy. Different sectors of the economy each have their own reasons for their prices; some sectors go up while others may go down. The inflation rate tries to take all of these factors in their entirety and combine them into a single statistic.
The most common cause of inflation comes from an increase in aggregate demand, which can be considered total expenditure. An increase in spending in one area usually corresponds to a decrease in spending in other areas because people’s budgets are limited, so the total spending in this case remains unchanged. For total spending to increase overall, either the rate at which people spend money must increase, or the total amount of money circulating in the economy must increase. Over the past 100 years, the increase in the total money supply has been the primary cause of inflation. It is simply because if there is more money, more money is spent.
But how does this mechanism work? In the United States, the Federal Reserve Bank (aka “the Fed”) manages the money supply by manipulating the market for loanable funds. It is the market where individuals, businesses and governments borrow money on credit from a bank. The Fed creates new money out of thin air and gives it to banks who then lend it out for cheap credit. This is the first step. People take advantage of these low interest loans and buy things like a mortgage, college education, factory equipment, or a flood diversion construction project. This initial expenditure is how it trickles down to the wider economy, stage two.
This initial expense becomes income for other people who then spend their money on what they want. Now that there is more total money in the economy, companies realize that they have more customers, so they place orders with their suppliers to try to meet this new demand. Companies are also trying to hire more workers to do these new jobs. Business is booming, step three.
But suppliers end up being stretched thin because there aren’t enough materials for everyone. This additional competition for rare materials leads to increased costs for the company. Similarly, there are not enough workers to fill all job vacancies. Employers have to raise wages to attract workers if they want the job done, which also increases the cost of doing business. The economy becomes overheated, stage four. Faced with this increase in production costs, retailers have no choice but to raise their own prices, step five.
With higher prices, consumers slow down and demand less. Companies don’t see as much demand for their products. In turn, suppliers are not as tense and job offers disappear. The level of production in the economy is now back to its starting point, but now everything is more expensive, step six. This is where inflation comes from.
Look out your window now. There is a labor shortage; I’m sure you’ve heard about it on the news. Talk to local business owners; the prices of supplies have increased: wood, oil, beef, freight and international maritime transport. The symptoms of inflation are all there; you can see it everywhere you look. But what about the cause?
In the two years since January 2020, just before the pandemic, the total money supply, what economists call “M2” which includes physical cash, electronic deposits and short-term liquid savings like CD, all of this increased by 40%. The amount of monetary creation in recent months is unprecedented. The news has just fallen that inflation in 2021 has reached 7%, the highest in 40 years.
Who could have seen this coming?
Everybody, who is it.
Why is the Fed creating so much money? Because they want to keep the interest rate low to help businesses through the pandemic, but the interest rate isn’t staying low as the federal government spends many trillions of dollars every year, money that He does not have. If we are to restore stability to our economy, either the Fed must let interest rates rise, which would cause its own problems, or the federal government must stop spending money, which would also cause problems.
But make no mistake, the inflation we are seeing is caused by our incompetent government.
PS – No, I don’t believe that the increase in unemployment benefits caused the labor shortage.
William Smith lives in Fargo.
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