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The market has been a bit chaotic lately as it digests the geopolitical events of the last few weeks. Volatility is back, not just for stocks but for oil, gold and crypto too. We believe all of this has renewed inflation fears, even as evidence mounts that the economy is slowing.
Inflation has been a topic that has been in the news a lot lately, perhaps more than at any other time since the 1980s. That’s a good thing, because if no one has been talking about inflation, it could be because it has not been a problem. Inflation is just an increase in prices over time, usually across wide swaths of the economy. In the United States, inflation is commonly measured by changes in the Consumer Price Index (“CPI”).
The CPI is the weighted average prices of a basket of goods and services, including housing, transportation, food, energy and medical care. (Source: US Bureau of Labor Statistics) The goods and services used are intended to reflect an average American family’s consumption, and the weighting is intended to approximate the weight of each component in the average family’s budget. The CPI is intended to assess how price changes in the economy impact the cost of living.
In high school economics, we were taught that inflation is caused by too much money chasing too few goods. While that is a good basic definition, there are several different types of inflation, including demand-pull and cost-push; these types can be caused by several factors, including increased money supply, rising wages and policies and regulations. (Source: Business Insider)
In the real world, inflation is often caused by several of these factors at the same time. Demand-push is when demand for certain goods and services outpaces the economy’s ability to meet that demand. Cost-push occurs when the cost of basic inputs for a product or service goes up and the producer can pass those costs along to consumers. Increased money supply causes inflation if the increase is greater than increases in the rate of production, causing demand-push inflation. Wages are a cost of production, so when wages increase quickly, the result can be cost-push inflation. Tax policy, government subsidies and regulation can also cause inflation.
One of the main purposes of central banks is to maintain price stability. In the United States, that role is filled by the Federal Reserve (“Fed”). The Fed usually has a target rate for inflation, and for years it has been 2%. The Fed has been largely successful in maintaining that rate. In fact, inflation has often come in below that target for several years. Recently, the Fed has indicated that it will be willing to accept a higher rate of inflation for a period of time. (Source: Bloomberg)
The current bout with inflation has proven to be more durable than the Fed initially believed, and the Fed has reacted by aggressively raising interest rates. During the pandemic, the Fed had kept rates at near zero to stimulate the economy. Too much stimulus can result in an overheated economy, and raising rates has a chilling effect on the economy. When rates are higher, it makes buying things like homes and cars more expensive, which decreases demand for those things.
Hopefully, the Fed’s decisions will continue to bring inflation under control. Regardless, this may be a good time to evaluate the potential effects of inflation on your investments.
Important Disclosure: Mike Bergen is a Partner, Managing Director at Beacon Pointe Advisors LLC. The information contained in this article is for general informational purposes only. Opinions referenced are as of the publication date and may be modified due to changes in the market or economic conditions and may not necessarily come to pass. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified or attested to the accuracy or authenticity of the information. The discussions, outlook and viewpoints featured are not intended to be investment advice and do not consider specific investment objectives or risk tolerance you may have. All investments involve risks, including the loss of principal. Consult your financial professional for guidance specific to your circumstances.
