What is inflation, and why is it so bad?

A new reports says that inflation is surging, by about 7.5 percent annually, which is the worst it's been since 1982. What is inflation, and why is it such a bad thing? The Consumer Price Index for January, 2022, rose 7.5 percent overall. 

What is inflation, and why is it bad?

Highlights

By Marshall Connolly (Catholic Online)
2/10/2022 (2 years ago)

Published in Business & Economics

Keywords: Inflation, cost, prices, effect

LOS ANGELES, CA (California Network) - Inflation is the rise of prices over time. 

The fundamental economic problem is scarcity. There is only so much time, money, and resources available to produce things we demand, so difficult choices must be made. Scarcity also drives prices, and as people choose to produce one thing or another, or as shortages, develop, prices tend to rise. Prices can also rise if the supply of money increases. As more money circulates through the economy, prices are raised so those who provide goods and services can enjoy more profit. 

This is normal economic behavior, and it is natural for prices to rise slowly over time. However, when prices go up faster than wages do, it creates pain for consumers because it has the same effect as a pay cut. 

Here's an example: Mary uses 20 gallons of gasoline per week to get around. Gas costs $3.00 per gallon, so she must pay $60 per week to meet this need. However, inflation, caused by any number of factors, causes the price to rise. Now, gas costs $4.00 per gallon, increasing Mary's expense to $80 per week. 

Mary may ask her boss for a raise, since she is a good worker. Her boss finds she can pay Mary an additional $10 per week. It isn't much, but it is what the company can afford. 

Sadly, at the end of the week, even with the raise, Mary's purchasing power is -$10! The benefit of her raise was wiped out by inflation. In effect, even with the raise, inflation effectively gave Mary a pay cut of $10 per week, or $40 per month. Mary must now either cut her expenses by $40, or find another way to earn $40. Of course, the simplest course of action is to cut, which means another business out there is going to be making less money from Mary's spending. Now, multiply this by hundreds of millions of consumers, and you begin to see the danger. 

For Americans, this is exactly what is happening across the nation. Supply shocks, an oversupply of money in the economy (of which the vast majority went to Wall Street), and price increases (even among firms showing record profits) is putting household budgets in a bind. 

Even workers who did well during COVID and got raises, are losing purchasing power to inflation. In short, Americans are in effect, suffering pay cuts, even when their bosses are generous. 

The problem this creates is thus: eventually consumers must slow and stop spending in order to survive. They must substitute premium products for ersatz ones, they must cut discretionary expenses such as travel and entertainment, and they will eventually be driven into the market to compete for additional work. Unfortunately, this causes the number of workers available to boom, which in turn puts downward pressure on wages, and accelerates the problem. Eventually, as purchasing power declines, entire sectors of the economy can be contaminated, such as the housing market, which cannot sustain high prices when people aren't being paid enough to buy houses. This impacts the financial sector, and so on until the entire economy goes into recession. 

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Eventually, these forces also pull the economy back out of recession, and into expansion. However, that can take a long time, often months or even years. This natural ebb and flow has its own name, it is called the "business cycle."

To combat these problems, the government and banks use tools, called monetary and fiscal policy. However, these tools are supposed to prevent inflation from getting this bad in the first place, and aren't working very well right now. Their use can also create pain for consumers. 

As workers find their pay no longer compensates them enough to maintain their customary standards of living, they will begin to demand raises from bosses, and even quit work to find more lucrative employment, or to start their own businesses. This in and of itself isn't a bad thing, but it can be disruptive. In fact, the Great Resignation is part of this, although that has been fueled by outdated and unpopular workplace policies as much as by low wages, according to studies. 

Unless the current administration can do something that will put more money into the hands of workers, the working class, and especially the middle class, will suffer greatly. Small businesses will also be impacted, since they are the ones least able to keep up with sudden changes in economic conditions. 

Sadly, the policies that could make the most difference are the least popular right now. Employers,. recently squeezed for a round of raises in the last year, are reluctant to pay out more, especially small businesses. Stimulus checks and tax cuts for individual taxpayers are being blamed for inflation, and for people staying home from work, so they are highly unlikely to be resurrected. However, these policies are just scapegoats for the real culprit, which is Wall Street greed. Stimulus in the trillions went directly to Wall Street, and many firms have raised prices, and decreased value to consumers (smaller portion sizes, poorer customer service, less choice) not in response to fundamental market forces beyond their control, but simply because they can thanks to the public perception of inflation. These firms are reporting record profits to shareholders while raising prices on consumers, and blaming "inflation" when they are clearly unaffected by it in a meaningful way. 

However, that is not the conversation the people or their politicians are having, and so we can expect the pain will continue for the foreseeable future. 

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