With increased access to money due to monetary inflation, companies and consumers may raise demand and drive up inflation across the board. As such a gloomy future loom over us, let’s take a look at the 3 different types of inflation.
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The headlines are dominated by inflation as prices reach 40-year highs.
While the cost of necessities like food and energy is the sort of inflation that receives the most attention, other types of inflation can be found throughout the entire economic system.
1. Monetary Inflation
When the amount of money in the United States rises over time, monetary inflation results. This symbolizes the economic flow of both physical and digital currency, such as cash, bank accounts, and money market mutual funds.
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The U.S. central bank frequently modifies bank reserve requirements, purchases bonds, and money printing to affect the money supply. In order to stimulate the economy, limit inflation, and maintain stable prices, the central bank regulates the money supply.
In reaction to the COVID-19 crisis, the money supply rose by about 25% between 2020 and 2021, setting a record. Since then, when the economy started to show indications of strength, the Federal Reserve started to reduce its bond purchases.
It is important to remember that, in theory, raising the money supply more quickly than real output growth may lead to consumer price inflation, particularly if the velocity of money—the rate at which money moves—is high. The rationale is that more money is vying for the same amount of commodities, which finally drives up prices.
2. Consumer Price Inflation
When the cost of goods and services rises, consumer price inflation develops. The Consumer Price Index (CPI), which displays the average price growth of a basket of commodities like food, clothing, and housing, is commonly used to measure it.
Consumer price inflation may be impacted by problems with the supply chain, geopolitical developments, monetary supply, and consumer demand.
The CPI reached its highest level in four decades in May, rising 8.6 percent year over year. The invasion of Ukraine by Russia and COVID-19 have severely disrupted global supply networks for everything from wheat to oil, raising price pressures across the board.
The central bank may raise interest rates to reduce spending and enable prices to stabilize when consumer price inflation becomes out of control.
3. Asset-Price Inflation
The price rise of stocks, bonds, real estate, and other financial assets over time is referred to as asset-price inflation. We shall use household net worth as a percentage of GDP even though there are other ways to illustrate asset-price inflation.
The atmosphere for asset prices is frequently favorable when interest rates are low. Over the past ten years, this has been evident as low borrowing costs have been accompanied by growing asset prices and a high level of investor confidence. Household net wealth as a portion of GDP was 620 percent in 2021.
Since little actual output is being created, increasing asset prices can occasionally be a deceptive indicator of a thriving economy. This may instead be a sign of an asset bubble.
How the Types of Inflation Impact You
With increased access to money due to monetary inflation, companies and consumers may raise demand and drive up inflation across the board.
It is not always obvious, though, how much this affects consumer price inflation. The money supply exploded during the past ten years, but inflation of consumer prices remained largely steady. Rather, the invasion of Ukraine and supply shocks like COVID-19 have had a more immediate impact. Prices are thus more susceptible to changes in demand as a result of this product shortage. With petrol prices at all-time highs, this is evident.
Low interest rates and a substantial growth in the money supply are possible causes of escalating asset prices, among other factors, in the case of asset price inflation. The future of asset price inflation, however, is uncertain as the Federal Reserve adopts a more hawkish position on monetary policy.