Inflation is approaching a 40-year high, owing to sharp increases in food, housing, and utility prices.
The Federal Reserve is attempting to reduce it by aggressively raising interest rates, even if it means bringing the economy closer to a recession.
Still, prices are rising, making it more difficult for many Americans to make ends meet.
The Consumer Price Index, or CPI, report is due Tuesday and will provide important information on the prices of various consumer goods and services, as well as how much they have risen in the previous month and year. The data will indicate whether or not inflation is beginning to slow.
While it is simple to observe and measure price changes, it is more difficult to comprehend them.
Aside from costs, inflation can have an impact on employment and wages.
So, what exactly is inflation, and why does it occur?
What exactly is inflation?
Inflation is defined as a “generalised rise in prices,” according to Josh Bivens, research director at the Economic Policy Institute, a left-leaning think tank based in Washington, D.C. Inflation can affect items such as gasoline, rent, and food.
“However, inflation is really only meant to refer to all goods and services rising in price by some common amount,” he explained.
What is the source of inflation?
Several factors can contribute to inflation. “A macroeconomic excess of spending over the economy’s relative ability to produce goods and services,” according to Bivens, is the most common.
In this case, as more people spend money on goods or services that are not readily available to meet demand, producers begin to raise prices.
“If everyone in the economy decided tomorrow that they weren’t going to save any money from their paychecks and that they were just going to spend every last dollar out of the blue,” Bivens said. “However, producers have not produced enough to meet the large increase in overall spending. As a result, prices would rise.”
A lack of producers is another source of inflation. If there aren’t enough workers to produce the desired good or service, prices will rise, according to Bivens.
“The primary component of the cost of producing anything is labour,” he explained.
There is also a level of “built-in inflation” within economies, where systems attempt to keep inflation at a constant percent.
The Federal Reserve System’s target inflation rate in the United States is 2%. This means that businesses can raise their prices by 2% per year while remaining competitive in the market. Workers can also request a 2% wage increase based on these increases in order to continue affording goods and services.
Is inflation beneficial or detrimental?
According to Bivens, inflation is both good and bad.
“Inflation is currently at an all-time high (in 2022). It’s far too high. It’s moving too quickly “He stated. However, if inflation rates are consistent, positive, and low, he believes they can be beneficial.
“Inflation is lubricating the labour market,” Bivens explained. “It’s a way to make some adjustments without having to cut nominal wages, and the economy just seems to run better that way.”
However, if inflation exceeds the target percentage, it can cause market uncertainty.
“Whatever your goal is, you don’t want to go too far above it. You want people to be able to make plans and know how much prices and wages will rise in the coming year “Bivens stated.
Who suffers as a result of inflation?
Inflation can harm those who spend the most money on goods and services.
For example, when gas or food prices rise, low- and moderate-income families suffer because they spend a larger proportion of their total income on energy and food, according to Bivens.
Will there be a recession as a result of inflation?
According to Bivens, inflation and recession are inextricably linked.
“A significant increase in the unemployment rate will put a lot of downward pressure on inflation,” he said. “Inflationary pressures tend to ease as the economy slows.”
A recession is not defined by a negative quarter of gross domestic product, or even two. Rather, it is a significant decline in economic activity caused by a number of factors, including high unemployment, a slowdown in the production and sale of goods, and falling wages, in addition to negative GDP readings.
That’s according to the National Bureau of Economic Research, which makes the official call on when a recession in the United States begins and ends.
So, while inflation may cause a recession, it is not a foregone conclusion.