What is the cause of inflation in US

What is inflation?

In the financial sense of the word, inflation refers to an increase in prices over time, which subsequently leads to a decline in the purchasing power of money. If a Socks cost $10 last year and prices have risen 5% this year, you can expect the socks to now cost $10.50, so you'll need 5% more money to buy it. In other words, if you had put $10 in cash, it is now worth less. It used to be enough to buy socks, but it's no longer the case.

Inflation depends on a bunch of economic factors, and there are many ways to calculate it. The most common way to measure inflation in the US is the Department of Labor Consumer Price Index (CPI), which uses a representative basket of goods and services to determine trends in prices over time.

We'll measure inflation in the US with the CPI and other common methods later, but the key point is that inflation is a comparison of the current purchasing power of money with the purchasing power of the same amount at the some point in past.

As a general rule, when the economy is healthy, a moderate (low single-digit) inflation rate is expected. Part of the Federal Reserve's mandate is to keep inflation under control, and the central bank currently targets a 2% inflation rate.

It is entirely possible to have negative inflation, which means that prices tend to decline over time. This is known as deflation, and is often seen in tough economic times.

Sometimes inflation can be a little confusing if the price of a certain commodity skyrockets or falls. For example, if gasoline prices fall by 50%, it may reflect the inflation rate lower than real because the widely used commodity is priced significantly lower.

Current inflation rate

According to the Bureau of Labor Statistics (BLS), inflation in the US rose by 0.3% in April 2022. Because it is a backwards indicator, the most recent inflation figure will always be the previous month. In the past 12 months, the all-commodities index increased by 8.3% before seasonal adjustment.

To calculate inflation in the US, we start with a "market basket" of goods and services. The price level of this "market basket" is the one that is measured from month to month. This basket is meant to hold a portion of the goods and services that urban households typically consume, but is not meant to include all. Using that market basket, a consumer price index is created and the current value of the market basket is determined by adding up each sum.

The next step is to compare the cost of the current market basket of commodities with the same market basket of commodities called the base period. Inflation is then calculated by the change in price level from the market basket of goods in the base period compared to the market basket of goods in the most recent period. For example: If the CPI is 255 in March 2021 and rises to 260 in March 2022, it would mean that inflation was 1.9% in that 12-month period.

What is the cause of inflation in US?

Before we get into the causes of inflation in the US, it is important to point out that a modest level of inflation is part of a healthy economy. While it is never fun to watch prices rise for everyday purchases, it is an economic phenomenon that is more helpful than harmful in the long run, as long as it is kept under control.

There are two main drivers of inflation:

• Cost-push inflation: This occurs when the cost of production for some goods increases, and manufacturers pass the increased cost on to consumers. For example, if the price of lumber rises, it usually leads to an increase in home prices because it costs builders more to build the house. Labor cost is also in this category because the more expensive labor force adds to the cost of the goods produced.

• Demand-pull inflation: This occurs when the demand for goods increases, and hence prices rise. Continuing the home construction example, the low inventory of homes for sale relative to the number of buyers in the market is a good example of demand-pull inflation.

• Increased money supply: An increased money supply is defined as the total amount of money in circulation, which includes cash, coins and balances and bank accounts, according to the Federal Reserve. If the money supply grows faster than the rate of production, it can lead to inflation, especially demand-inflation, as there will be too many dollars chasing too few products. Increases in the money supply are usually done by the Federal Reserve through a process called open market operations (OMOs).

• Devaluation: Devaluation is a downward adjustment in the exchange rate of a country, resulting in a decrease in the value of a country's currency.

A devaluation of a currency makes a country's exports less expensive, encouraging foreign countries to buy more devalued goods. Devaluation also makes foreign products more expensive for the devaluing country which encourages the devaluing country's citizens to buy domestic products over foreign imports.

• Rising Wages: Rising wages are exactly what it sounds like - an increase in wages paid to workers. "Wages are the cost of production," Baker says. "If wages increase by a large amount, businesses will either have to cover costs, or live with lower margins. The exception is if they can offset wage growth with higher productivity."

However, economists remain mixed on the impact of gradual increases in wages, such as raising the minimum wage, compared to the sharper, more abrupt wage increases seen in places like Silicon Valley. Some believe the increase in wages may lead to cost-push inflation due to higher costs to businesses, while others believe that higher wages across the board (not just concentrated in certain sectors) to offset the spike in prices. will increase demand substantially. ,

Rising wages should allow consumers to counter inflation, especially if wages are rising at the same or faster rate than the inflation rate," says Susan L. Tony, PhD, thriving chair of business and economics at Hampton University. "Rising wages allow consumers to pay higher prices without affecting their purchasing power."

• Policies and Regulations: Some policies can lead to either cost-push or demand-inflation. When the government releases tax subsidies for certain products, it can increase demand. If that demand exceeds supply, costs can increase. Additionally, stricter building regulations and even rent stabilization policies can inadvertently increase costs and create an inflationary environment by passing those costs on to residents or by artificially reducing the housing supply.

How does inflation affect stocks?

Different companies are affected by inflation in different ways. If a company can raise prices without significantly affecting demand, inflation can lead to higher corporate profits. On the other hand, if demand for a company's product declines as a result of rising prices, a higher rate of inflation can be a negative catalyst.

Ways to measure inflation

As mentioned earlier, the primary way to determine inflation is by comparing the Consumer Price Index, or CPI, to its historical values. We won't delve too deeply into the math, but the CPI is designed to represent the cost of a basket of goods and services typically purchased by urban workers. Specifically, the version of the CPI used to measure inflation is the CPI-U, or the Consumer Price Index for All Urban Consumers.

There are some other variations of the CPI that are not commonly used for headline inflation numbers, but may be more useful in certain situations. For example, the CPI-W is the CPI for urban wage earners and is designed to be more representative of hourly wages and expenses incurred by clerical workers.

Why inflation is important

The main thing you should note here is that cash really does lose value in the long run. This is why investing is so important. Stocks, bonds and even real estate have historically profited significantly from inflation rates. Savings accounts, not so much, especially in the current environment of almost zero interest rates.

So if you have a bunch of cash in a savings account, or worse, under your mattress, you should seriously consider putting that money to work. You don't even need to be a stock market expert. Some basic index funds may do just fine. Whatever you do, don't let your money lose its value over the years. By not investing, you are literally asking your money to lose its purchasing power.