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Inflation – How It Works

hyperinflation

Everywhere, inflation is with us – gas pump, groceries, clothes, and even basics, like a toothbrush and toothpaste.  Question – the real question – is why? Why is the value of a dollar earned and saved shrinking?  Politicians want your ear, but here is reality – how inflation works and what to expect.

First, inflation is not a political term – it is pure economics. It describes a change in the real value of money, based on the state of an economy, where the real value of goods and services is outrun by government spending, or people see a shortage of something like food or energy, driving up prices.

Stability matters a lot. Consumers have established expectations, creating consistent demand for certain products. If these are suddenly in short supply, prices go up. Or if demand jumps, overtaking supply, prices go up. 

Another cause of inflation is an overheating economy, one in which growth is rapid, pushing prices up with consumption, as the price of inputs – material and wages – go up fast, everyone working hard.

Generally, inflation is just an increase in prices, which reduces the purchasing power of money.  Of course, most of us want money to be worth what it was when we earned it, and when we saved it, so that we can buy things we expected to be able to buy with it. 

So, how do you restore stability to the currency, create predictability, calm people’s hearts, so they can reasonably expect earning power and their savings to be worth about the same year to year?

The answer: You need to get at real root causes, what created a sudden inflation spike. This is how politics muddies the water – with competing narratives. 

Those responsible for overspending, taking more dollars out of the economy than expected, then trying to pay for that less-productive spending with higher taxes and just printing more dollar bills, tend to upset the apple cart. 

Government overspending does not create the same outputs that leaving dollars in the private sector does.  The so-called “multiplier effect” of a dollar in the private sector, the number of times that dollar changes hands, creating jobs, is far higher than government spending.

However, those responsible for government overspending – and thus inflation – do not like to admit overspending affects the value of dollars people earn and save, so they tout the government program.

A second cause of inflation, of course, is a shortage. Understanding how a shortage occurs is key.  Currently, in the US, we have an imbalance between supply and demand for energy, and of course, all those things are transported to market through the use of energy. This drives prices up, creating inflation.

Why the imbalance? The Biden White House – notably ignoring overspending during the past 14 months on extra federal COVID money, unemployment plus-ups, costly mandates, and regulations – says the inflation we are seeing is because of the Russia-Ukraine war, which triggered cutting off Russian oil.

The truth is elsewhere. Long before Russia-invaded Ukraine, in the first week of Biden’s Administration, policymakers said – we are against fossil fuels and for renewables, and then cut oil and natural gas exploration, drilling, fracking, production, refinement, and transport via the Keystone pipeline.

This was like hitting the US economy, energy independent under Trump, with a roundhouse. The entire economy shivered. Prices – from the start of Biden’s term – began rising. Long before Russia invaded Ukraine, we were suffering a had 7.5 percent inflation rate.

The reason is not mysterious. When demand remains constant, and supply falls, prices jump. When insufficient supply is then met by importing higher cost energy, that compounds the problem. What people could afford, they can no longer afford.

Then – because energy is needed to move things to market, from potatoes and beef to people in “Ubers” – the cost of all these products shoots up. Companies tack on service charges to cover costs.

So, this is how inflation really works and is being created by Biden’s policies.  Yes, they finally cut oil imports from Russia, but that is nothing. The real cause is unrestrained federal spending and federal decisions hammering the energy sector. That narrative is the right one. 

And here’s the kicker, a prediction. These two causes of inflation will not go away on current policies.  They will recede only when federal spending goes down, and US energy production goes up. Higher taxes only slows the economy, taking more from private sector productivity.

To fix inflation in a high-growth or overheated economy, the Fed raises interest rates, which slows accelerated borrowing and cools or flattens the inflation curve. But we are not in a high-growth economy, just one burdened by too much debt and too little energy production. 

So, what will Biden’s policies mean when the Fed reflexively raises interest rates? In a struggling economy, it will mean a slump.  

In short, if you add the real reasons for inflation to falling real wages, rising prices, higher taxes, higher cost of borrowing, you get less spending, hiring, and investment, higher unemployment, and what economists – remembering Jimmy Carter’s dismal days – “stagflation.”

Net-net, the Biden White House, and Democrats have given us a goose egg, an economy that could be growing – led by the energy sector, lower taxes, less spending, and fewer mandates – but instead is being slowed by federal mismanagement. As job creation falls, with real wages, savings, and the dollar, expect some choppy waters. Good news: When those policies are reversed, the economy should take off.


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Tony
2 months ago

This article talks about the side effects of government policy but not the basic cause of inflation.
Inflation comes from the excess printing of money- $, etc. all the other “causes” are the result of the excess printing.
Clinton, Obama, Trump (yes Trump) and Biden have all allowed the FRB and the Treasury to cause the problem.
The money supply worldwide has exceeded productivity worldwide hence inflation worldwide.

David Kovacich
2 months ago

How do we get AMAC to start a grassroots effort to repeal the Federal Reserve Act of 1913? No one knows how much money goes to the private Federal Reserve Banks every year for every dollar that is in, or thought to be in, circulation. The U S Treasury needs to be solely in charge of the distribution and control of our dollars as our Constitution dictates. The money going to the Fed during the Clinton Admin. was sufficient to pay off the National debt.

Tim D.
3 months ago

It just amazes me how many consumers do not understand the simplicity of economics. Folks will allow their wallets get torched and expect government to “send them a check” to “fix” the problem. Always remember… Government doesn’t have any money or earn it. IT’S YOURS, the taxpayer, the one trying to make ends meet and trying to earn more. They(the gov’ment) are happily wasting YOUR money every day, all the while telling you that your not “giving” them enough. It will NEVER be enough unless THEY get their hands off of it. This article explains very clearly what inflation is and how it gets adjusted, and clearly the government, as ALWAYS needs to stop meddling in places it was NEVER supposed to.

Mic J Palazzolo
3 months ago

Economic inflation: An increase in money supply without a commensurate increase in productivity.

Dave
3 months ago

Pretty sad when someone needs to spell the word ‘inflation’ and be able to use it in a sentence to people who are old enough to remember the Carter years…

Well Dick, I give it a ’35’ because it doesn’t have a good beat and I couldn’t dance to it worth a s*it…

PaulE
3 months ago

Very well written article on what both inflation really is, as well as how the policies of the Democrat Party and the Biden administration caused the worst inflationary spike since the Carter era. The solution is of course to completely reverse the destructive policies that now exist. However, that will only likely occur once the current Democrat President, and his Party’s policies, are completely replaced by a Republician President who reinstitutes the same pro-growth, pro-American policies that were implemented by the Trump administration. Note I say both a Republican President and one that copies EXACTLY the policies of the Trump administration. What we CANNOT do is elect some so-called “moderate” or “reach across the aisle” type RINO, that only partially undoes some of the destructive Democrat policies now in place for the sake of “compromise” (trying to NOT offend the far left of the Democrat Party too much). Halfway measures will not achieve the desired the results the American people need to restore the economy. We either want sound economic and fiscal policies or we want political correctness that delivers what we are living through today.

As for the study of economics itself, much of what is taught in today’s modern colleges and universities is not sound economic and financial theory. Instead, what is being taught is MMT (Modern Monetary Theory) or something very closely aligned to it, but called by a different name to mask what is being taught. All sprinkled heavily with the tenets of socialism to give it an air of “social righteousness”. That is what has been instituted by the Biden administration and the Democrats running Congress since Day One of Biden’s term. So is it any wonder that a growing percentage of the American population has no firm understanding of what should be prudent economic policy that the government should be adhering to?

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