What Is Inflation?
Inflation is an economic term that describes rising prices, which can result in a decline in purchasing power over time. The rate at which purchasing power declines can be represented by the average price increase of a selected set of goods and services over some time.
For example, let’s say you own a grocery store and a basket of potatoes that cost you $50 two years ago now costs you $60. Obviously, the potato basket has not changed, but it has become 20% more expensive. A devaluation of the currency used in any given economy is a by-product of inflation. Thus, when everyday goods and services prices rise, consumers’ money earned and saved is worth less than before.
Indeed, some inflation is neither good nor bad but a natural process within a healthy economy. It’s simply a reflection of many other uncontrollable factors in an economy. Inflation is generally a response to two key factors: an increase in demand and costs. And it’s these two factors that largely determine the severity of the inflation.
Increased consumer demand for a product is considered a more positive indicator of inflation. It occurs when an economy has more money and can afford more goods and services. This increase in demand eventually leads to a decrease in supply, which causes businesses to raise their prices.
On the other hand, cost-push inflation is generally a more damaging form of inflation, as it occurs when input expenditures increase. Rising prices often offset a firm’s rising direct and indirect costs.
Both forms of inflation are typical and expected in the life of an economy. According to the Federal Reserve, the normal annual inflation rate in the United States is 1.5% to 2%. At this rate of inflation, economies can grow reasonably and without drastic changes in consumer or business behavior.
Unfortunately, the annual inflation rate in the U.S. accelerated to 9.1 percent in June 2022, the highest level since November 1981, up from 8.6 percent in May and above the market forecast of 8.8 percent. But that didn’t prevent retail sales from increasing exponentially. In fact, retail sales grew a record 14.1% in 2021, the highest growth rate in over 20 years and well above the 3.7% growth rate prior to the pandemic. In other words, U.S. consumers spent $1 trillion more on retail goods in 2021 than in 2020 and are spending at an even higher rate in 2022.