Why Inflation is an Increase in Money Supply, Not Price
The year 2021, one financial term has been on the lips of many people from Wall Street to Main Street - Inflation. Recently, it has been reported that consumer prices have spiked 13%. Therefore, many people are under the impression that inflation is all about the increase in prices. However, this is not the case. The cause of inflation is the increase in money supply. Here’s a close look at the difference between inflation and price increase.
What is behind the price increases?
Recently, we have seen price increases in a number of items including food, used cars, and lumber. However, each of these price increases are the results of supply shortages. Once the supply shortage has been fixed, the rate of price increases for these items will stabilize. However, these price increases are not directly related to the class deduction of inflation.
What really causes inflation?
According to economists, inflation is caused when the money supply exceeds the growth of real output. For instance, take what happened in Weimar Germany. The government was dealing with crippling debt due to its repayment obligations following World War 1. Germany was in a depression and had low real output. However, the government decided to rapidly increase its money supply in order to pay back its war debt. The incredible divergence between real output and the money supply lead to hyperinflation.
Is there high inflation in the United States?
As of May 2021, the year over year inflation rate in the United States is at 5.4%. This is the highest rate of year over year inflation since July of 2008. That means that we are currently experiencing a huge influx in the money supply that far exceeds the real output of the country. In order to bring inflation back to its recent 2% year over year level, the money supply needs to go down the real output levels or real output levels need to rise to money supply levels.
What most people get wrong about inflation
When people look at the economic situation in the United States, they assume that there has been high inflation for years. This is simply not true. Yes, the government has printed an incredible amount of money over the past 40 years. However, the United States has experienced high real output in the same amount of time. As long as real output is high, the money supply can remain high. However, when real output goes down, like it did during the 2020 COVID-19 pandemic, and the money supply goes up to help support people and businesses, then inflation rises.
Knowing more about inflation can help protect your wealth
Knowing the true definition of inflation can greatly help you understand the economy and how to best position your investment. If you want to stay on top of the latest inflation numbers, be sure to check out the monthly Consumer Price Index report released each month by the U.S. Department of Labor. The more you know about inflation, the better.
REFERENCE:
https://www.economicshelp.org/blog/111/inflation/money-supply-inflation/
https://www.usinflationcalculator.com/inflation/current-inflation-rates/
