Inflation 101

Yesterday, it was announced that wholesale prices jumped a full percentage point higher than expected (see the Washington Post story from 12/15/09). That stoked some fears that inflation was gaining steam, and caused the stock markets to drop throughout the day. On top of everything else consumers are going through… nobody wants to see inflation get out of control.

But today, it was announced that consumer prices did not rise as much as expected (see the Washington Post story from 12/16/09). Yes, prices are up a little, but only a little, suggesting that inflation is still at a modest and acceptable level.

Implications: What does it mean… if producer prices are up considerably, but consumer prices are up only modestly? I’m no economist, but I suspect it means somewhere between the producer and the consumer, people are feeling the squeeze… and margins are getting smaller.

Because almost every recession is followed by a period of at least a little inflation, it might be a good time to get your head around this fundamental economic concept. You have to start by realizing that inflation can be both good and bad.

A little inflation can be a good thing… because it can be a signal of economic recovery. Stockpiles have been depleted as companies have avoided warehousing goods in response to weak consumer demand throughout the recession. When the recession fades and demand resumes, there is often too little supply to meet that demand… and prices are forced upward.

Inflation can be bad because it means the same dollar will purchase fewer goods… either because the same goods are worth more, or the dollars that buy those goods are worth less. That can scare the consumer. (A consumer that is already a bit skittish right now.) The dollar can rise or fall in value for the same reason anything else does: the laws of supply and demand. If the money supply grows too far too fast (and there is not enough gold in the treasury to support those dollars), the value of a dollar can fall. The money supply is largely controlled by the Federal Reserve, and influenced by interest rates. That’s why a lot of folks will be watching whether the Fed’s “board of governors” signals an interest rate increase when they announce economic policy changes later today.

This morning’s news would indicate that, for now, inflation is not problematic. But before long, it could become a topic of conversation. So here are a few tools to help you brush-up on the basics:

Here’s a link to the Wikipedia article about inflation.

Here’s a link to some information about “the Fed” from “How Stuff Works.”

And here’s a link to The Federal Reserve website where you’ll find several options to gain more information, including an interactive tour of the Fed’s history.

Mike Anderson