Inflation | A Stake Original Series: Part 1
Inflation is everywhere…in headlines at least. A buzzword in markets and broader society since central banks turned on the “money-printers” to combat a Covid-19 induced downturn. To some it’s a cause for fear, to crypto-enthusiasts it underpins the thesis for “world-saving” Bitcoin, and to others, it’s an intriguing but unfamiliar concept.
Sure, the definition of inflation is obvious; an increase in the price of goods and services. In textbooks and headlines, those goods and services are measured in a basket known as the Consumer Price Index (CPI).
But inflation is a little more complex than whether CPI changes, to the point economists cannot agree if it’s even happening or not.
WTF is CPI?
Let’s start with the basics. As mentioned, inflation is an increase in the general price level of goods and services in an economy. Which goods and services? Statisticians piece together the Consumer Price Index, a weighted metric including food, gas, apparel, transport, and more.
Moderate inflation is good. The US Federal Reserve (the central bank) targets 2% inflation each year over the long run. Rising prices are a sign of a healthy economy. Economic growth is possible, wages can rise, debt is devalued. Too little and economies stagnate. Too much and currencies risk becoming worthless. Just look at Zimbabwe or Weimar Germany.
What do the numbers say
Is inflation happening right now? Let’s look at the US specifically as it has the greatest impact on global markets. CPI rose by 0.8% in April*, the greatest month-on-month increase since the 80s. Year-on-year, CPI is up 4.2%. So we’re seeing inflation way above targets?
Yet, according to CPI, prices are rising but there are a few things to note.
Firstly, rebounding from the worst economic period since 2008, prices are expected to rise sharply from a low base. Moreover, supply chain disruptions induced by Covid lockdowns are only short-term, say experts; 2% is the long-term target.
Secondly, those responsible for managing inflation don’t even use CPI. The US Federal Reserve is responsible for monetary policy in an effort to control inflation. They’re the team who run the “money printers”, a phrase we will cover in part 2.
The Fed gauges inflation using the Personal Consumption Expenditure Index (PCE). This metric factors in what people are actually buying, not what the sale price of certain items is. Sure, new cars may have risen in price by 20% but people may now buy used cars which have fallen by 10% instead. New cars shouldn’t factor so heavily into inflation if no one is buying them.
Food and energy are also taken out due to their seasonal and cyclical price nature. This adjusted figure measures core inflation. The latest release indicated a 1.8% increase since March last year. This is below their 2% target but is expected to soon pass 2%.
Is this a problem? What can we do about it? Read on next week as we release part 2.
In this section, we covered a definition of inflation, how it is measured and whether we are seeing inflation in the US economy. In part 2 we will cover what are the tools the Fed uses to combat inflation and its effect on the stock market.
*latest available figures at the time of writing.