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Getting Ahead: What Causes Inflation

Posted Sep 09, 2022 11:24 AM
By Alliance Community Task Force

by Patricia Jones, Alliance Community Task Force: Creating Opportunity

For several months now we’ve been dealing with inflation. Prices have gone up on our groceries, gas, rent, pretty much everything we buy. What causes inflation? Basically, it is an imbalance between supply and demand, and this year both of those are factors.

Usually inflation is demand-based. The high inflation of the 1970’s and 80’s was caused by baby boomers all becoming adults. They left home, needed cars, clothes, apartments; then they added houses, furniture, appliances, things for their own families. For the first time most women entered the labor market, so households had more money to spend. People were willing to buy more and pay more, so prices went up.

This round of inflation was set off by Covid. For a few months the world came to a standstill. Children didn’t go to school. Many people didn’t go to work. Factories, restaurants, transportation – so much was shut down. Goods that had been produced overseas sat in ships not allowed to dock and unload. Grocery store shelves sat empty; non-perishables were hoarded and fresh meat and produce couldn’t be processed. We’ve all heard about the “supply-chain problems.” We still have shortages of some items like semiconductors and fertilizer needed to produce other goods, what economists call supply constraints.

With so many people temporarily laid off, the government stepped up with some financial stimulus payments. The Federal Reserve cut interest rates to banks to zero. People spent a lot of time shopping and comparing on the Internet. Demand went way up for durable goods like appliances and entertainment systems. But the goods and services were not there. High demand plus low supply equals price increases.

After Covid vaccines were developed, people could return to work. However, not everyone chose to do so. Many took early retirement. Parents decided that one of them could stay home with children. The United States limited immigration. Our labor force participation is lower than it has been in decades. There are labor shortages in nearly every community. High demand for labor plus low supply means wages are going up.

Covid hit in early 2020. Now, two and a half years later, we are still seeing major effects. Many businesses had scaled back. This included oil refineries and airlines. If you’ve travelled this summer, you know airports are packed and flights are delayed. Ticket prices have skyrocketed. Tourist destinations are packed. We had lots of pent-up demand and want to get out again. And many of us saved money so we could.

One thing we cannot control will continue to create inflation problems for a while – the War between Russia and Ukraine. Why would the Ukraine crisis cause our prices to go up? Russia is the world’s third largest supplier of oil, after the United States and Saudi Arabia. Ukraine is a “breadbasket” nation, supplying grain for much of the eastern hemisphere. With those

products pulled from the world market, we will continue to see supply shortages and, therefore, higher prices.

Congress has passed the Inflation Reduction Act, controlling prescription drug prices and investing in energy production. The Federal Reserve has raised interest rates, making it harder for people to borrow money, as they try to lower demand. Their goal is to return inflation to rate of about 2%. But that probably won’t happen for a while.