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Understanding inflation

The news media keeps reporting that inflation is at 7.5%. What exactly does that mean?

Well, it really depends upon who's saying it. But typically the media reports inflation based upon information provided to it by the Bureau of Labor Statistics, which calculates its answer based on its self-created Consumer Price Index (CPI). The CPI is a hypothetical "basket of goods" bought by the average American, and the price of that basket is currently 7.5% more expensive than it was in January of last year.

There are three primary types of inflation: demand-pull inflation, cost-push inflation, and built-in inflation. Let’s take a look at each.

Demand-pull inflation

Demand-pull inflation occurs when there is greater demand for a product or service than availability, or supply. This is particularly noticeable in the food service industry. As a result of the pandemic, pent-up demand to dine out is surging. At the same time, more people are placing take-out orders. The supply of workers in the industry is diminishing, forcing owners to either limit their service hours or raise prices.

Online retail shopping has also been a heavy driver, not just in the demand for goods, but in the demand for goods quickly. Consumers have become reliant on “next-day delivery,” which requires more labor to meet the demand. As labor becomes more scarce, the prices must increase.

Cost-push inflation

When the costs of some goods and services increase, it triggers a correlating increase in other goods and services. For example, the price of lumber has skyrocketed in the last two years based on a number of supply constraints. As a result, the closely correlated cost of building a new home has also increased dramatically, which in turn has pumped up comparative property values.

Built-in inflation

When inflation causes prices to rise, workers’ wages tend to increase as well. This increase in wages creates new demand, which in turn causes prices to rise, completing the spiraling cycle known as built-in inflation.

We seem to have hit the perfect storm of all three in 2022, which is why inflation is at its highest level since the 1980s.

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