Considered to be the world’s biggest economy, the United States, has a highly significant impact on global finance. In the USA, inflation can affect the currency’s value, which, in turn, will impact international trade, exchange rates, and global investments. Further, it will influence other countries’ growth prospects and economic stability. Timely and accurate inflation rate analysis is fundamental to making an informed financial choice and adapting to the changing economic state.
What’s Inflation And How Is It Calculated?
An inflation rate is a change of percentage in the costs of products or services from one year to another. The two common ways to calculate inflation are the CPI (Consumer Price Index) calculated by the BLS (Bureau of Labor Statistics) and the PCE (personal consumption expenditures) price index by the BEA (Bureau of Economic Analysis). The consumer price index measures the true change in the prices paid by consumers over a while and is the best way to measure inflation.
The YOY or Year-Over-Year inflation rate can be calculated at a year’s start by subtracting its CPI value from the value at the end of a year. Then the result will be divided by the CPI value at a year start and multiplied by a hundred to have an accurate inflation rate percentage.
What Are the Causes of Inflation?
Inflation is a rise in the prices of products and services. Consumers lose their purchasing power when the prices increase. Besides the power of currency does not go far like before. Moderate inflation is not much of a concern but inflation may pose serious issues when prices rise very quickly.
The root cause of inflation is an increase in the money supply, which allows people to enter the markets for products, driving higher prices. In the United States, inflation is measured by CPI that bundles together purchased products or services and tracks down the price change. When inflation is slowdown it is termed as disinflation and price reduction is termed as deflation.
Certain causes of inflation include:
Demand-pull: The demand outpacing production capabilities causes the inflationary cycle, leading to an increase in prices.
Built-in inflation: Increase in inflation due to bargaining among people to maintain purchasing power.
Cost-push effect: The inflationary effect where the costs of production are pushed into the final cost.
Built-in inflation: Increase in inflation due to bargaining among people to maintain purchasing power.
Cost-push effect: The inflationary effect where the costs of production are pushed into the final cost.
Historical Trends of Inflation in the USA
The inflation in USA by year demonstrates how much costs for products and services increase every year. The rate generally reacts to the phases of a business cycle considered a natural phase of expansion & contraction that our economy goes through with time. Federal Reserve has a target yearly inflation rate of over 2%, and monetary policy is been used to keep the inflation in proper check and stabilize its economy when inflation increases above a particular benchmark.
1930 to 1940
- Deflation rules through the Depression Period.
- Costs recover in the thirties and turn downward once again.
- Close to WWII inflation reappears.
- The Depression period focuses on the prices.
1951 to 1970
- Price movements aren’t very volatile.
- Without any major crisis, rationing & price controls are absent.
- Fear of inflation even when the prices are stable.
- In the late 60s, inflation returned.
1980 to 2000
- In the early 80s, inflation reaches its highest peak.
- The early 90s see the re-emergence of substantial inflation.
- Stable inflation & low unemployment depict a long boom.
- During the recession, deflationary fears emerge among the people.
Current Trends of Inflation
Since the 1980s, the US has been able to maintain a stable inflation rate, but its inflation reached high levels between 2021 and 2022 due to the COVID-19 pandemic.
In 2021, the US inflation rate data went to 7.0%. It could be due to accommodative policies by the FR in reaction to various economic challenges faced by the pandemic. Certain factors like supply chain disruptions, higher consumer demand, and energy prices played a significant role in the inflationary trend.
After the year, the Fed started shaping its stimulus measures, slowly dampening the inflationary pressures. Thus, inflation reduced to 6.5% by the end of 2022.
In the US, the inflation rate stood at 3.18% in July 2023. The figure increased to over 3.67% in August; and in September 2023, the US inflation rate stayed at 3.70%.
In January 2024, the inflation rate dropped to 3.1% and rose to 3.2% and 3.5% in February & March respectively when it reached the highest mark of the year. But, in April, it again came down to 3.4%. To conclude, the current inflation rate stands at 3.3% for May 2024.
Why Does Inflation Take Place?
There are various reasons that inflation occurs, it could be variations in the supply & demand of various products and services that may ultimately lead to a rise in the costs linked with those products and services. Many other factors can also results increase in inflation including:
Wage-price spiral
It describes the link between increasing wages and costs. When we earn more money, the consumer demand for products or services increases which, in turn, will lead to higher costs.
Policy changes
Fiscal policies like low interest rates, increasing money supply, and cutting taxes will impact the inflation rate directly.
Changes in materials cost
Production costs also play an important role in determining the costs of consumer goods. When there is an increase in the production cost, the product price also increases. And this phenomenon is called cost-push inflation.
Bottlenecks in the supply chain
Supply constraints & shortages will result in a reduced supply of the product, which will cause more inflationary pressure.
High demand for products
When demand for the product increases than its supply, prices will skyrocket, even if supply remains the same. The analysis done by FRB, high consumer demand resulted in around 60% of the US inflation from the year 2019 to 2022.
It describes the link between increasing wages and costs. When we earn more money, the consumer demand for products or services increases which, in turn, will lead to higher costs.
Policy changes
Fiscal policies like low interest rates, increasing money supply, and cutting taxes will impact the inflation rate directly.
Changes in materials cost
Production costs also play an important role in determining the costs of consumer goods. When there is an increase in the production cost, the product price also increases. And this phenomenon is called cost-push inflation.
Bottlenecks in the supply chain
Supply constraints & shortages will result in a reduced supply of the product, which will cause more inflationary pressure.
High demand for products
When demand for the product increases than its supply, prices will skyrocket, even if supply remains the same. The analysis done by FRB, high consumer demand resulted in around 60% of the US inflation from the year 2019 to 2022.
Factors Affecting Annual Inflation Trends Rates in USA
Many factors can contribute to the rise of inflation. Generally, inflation will be a big concern if supply and demand go out of balance. Like, a limited fuel supply will likely result in increasing costs of gas if demand stays the same. In addition, better monetary policy with a larger money supply will reasonably support and push inflation higher.
Inflation is calculated by CPI, and at low rates, to keep the economy stable and healthy. However, when the inflation rate rises rapidly, then it will result in slower economic growth, lower buying power, increased interest rates, and various other negative effects. Let us look at some factors that can affect the annual inflation rates in the US and their impacts.
Factors Affecting Inflation
1. A tense labor market tends will result in wage pressures & increase inflation.
2. Higher rates of interest generally cause inflation to slow down.
3. Government interventions may alter inflation, like in subsidy cases that make particular items cheaper for the consumers. In contrast, fiscal stimulus or higher taxes will increase inflation.
4. The exchange rate can impact inflation just by altering the buying power of the national currency.
5. Prices of international commodities, like gas and oil price, can impact domestic inflation.
6. Capacity constraints through import restrictions, increase the costs of acquiring goods or can drive inflation up.
2. Higher rates of interest generally cause inflation to slow down.
3. Government interventions may alter inflation, like in subsidy cases that make particular items cheaper for the consumers. In contrast, fiscal stimulus or higher taxes will increase inflation.
4. The exchange rate can impact inflation just by altering the buying power of the national currency.
5. Prices of international commodities, like gas and oil price, can impact domestic inflation.
6. Capacity constraints through import restrictions, increase the costs of acquiring goods or can drive inflation up.
When input prices increase in production, companies lose their purchasing power & risk seeing the margins decline. These will include raw materials such as crude oil and coal, intermediate products like steel and flour, and other finished machinery. But, companies generally raise the costs of their goods and services to offset the inflation, which means consumers absorb the price increases. So, the challenge for various companies is maintaining the perfect balance between increased prices to cover the input cost rises while simultaneously ensuring they do not raise costs so much that it suppresses the demand.
Implications of the Inflation Rate
Even though it may just seem like a trend impacts the budget, inflation has a much higher impact on the economy. Let us explore some of the highly prevalent effects of increased inflation rates.
Lost of Buying Power
One obvious impact of inflation is the loss of buying power. As buying power erodes, many will feel the high impact on the budget. However, those on the fixed income or low income often feel its effect the most.
Since inflation takes hold, it is very important to check how well the income keeps proper pace with any changes. If it is in your power, then negotiate for the raise or you can switch up the income streams that will maintain the rising costs.
Measures to Anti-Inflation Will Cause Recession
Inflation is one major concern to the economy. However, as the Fed manages to adjust the economic market with the monetary policy & interest rate hikes, many times it overcorrects. If the market is not ready for any of such actions, that will mean lower growth for the nation. When it happens for a quarter, it’s referred to as a contraction. However, if it happens for two consecutive quarters, it is considered as the start of a recession.
During the recessionary environment, the often Fed lowers the interest rates just to encourage economic activity. However, as this cycle continues, it will be a very painful ride for everybody.
Lower-Income Consumers Get Impacted
The low-income consumers generally tend to spend a much higher percentage of their incomes on their necessities than those with higher incomes. Besides, they have less cushion against the loss of buying power that is inherent in inflation.
Financial market participants and policymakers focus on the core inflation. Such measurement of inflation excludes costs of energy and food as they generally tend to be highly volatile & less reflective of the longer-term inflation trends. However, earners with lower incomes spend a much higher percentage of their weekly and monthly household budgets on food energy, and commodities that are tough to substitute and go without when the rates spike.
Slow Down In Economic Growth
When inflation runs rampant, the Fed tightens the monetary policy. Once the money supply dries up, the credit becomes expensive & credit requirements tighten. So, the cost of borrowing money will be intentionally increased with the hope that this can reduce consumer spending & slow inflation.
But, consumers who want to make some major purchases may find this very challenging. As most require credit to make some major purchases, so result is it will slow down our economy.
Disruptions of Supply-Chain
Inflation does not disrupt supply chains; instead, supply-chain disruptions will cause inflation. Often inflation & supply-chain disruptions occur together, hence businesses must have a proper plan to handle such situations. When the supply chains get disrupted, businesses cannot get enough of the inputs that they want, and such lack of supply will result in prices increasing.
Most businesses become keen to pay more for the goods that are important to their products. Thus, it is a good practice to have different suppliers and to check the resilience of the supply chain; that practice will make a huge difference for the business during the high inflation times.
While differences in the inflation noted might appear simple, the price level changes seen in the economy are much more complex. So, in the dynamic economy, it is tough to isolate one single cause of change in its price level.
Conclusion
The inflation rate trend is a very important metric for measuring overall economic health. For this reason, it’s very closely screened by government officials, the Federal Reserve, and various economists. The central bank employs it to inform the monetary policy & what decisions should be made for keeping inflation close to 2% of the annual inflation target if possible, which includes fostering a stable economy with consistent supply and demand.
Just like another thing, inflation is better in moderation. Even though a low inflation level is considered good for the US economy, high inflation levels will make life a bit more difficult for a lot of consumers. Although inflation still is rising, the current slowdowns & improvements in the housing market are quite encouraging.
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