Inflation and the resulting government response has been at the forefront of recent news yet some people may be wondering: what does it all mean?
Inflation is the devaluing of a currency over the course of time. Put simply, inflation is when money can be used to purchase less and less goods and services because of higher prices.
Causes:
The primary causes can all be traced either back to the COVID pandemic or the war in Ukraine. Both of which have resulted in massive supply chain issues which cause prices to rise. The most notable “cost-push” factor that is driving up prices is oil.
Crude Oil is a major commodity that is used to produce gas and plastics. Right now, it is selling for $113 a barrel, up from around $68 where it was this time last year. The major reason is the loss of Russian oil due to NATO and other countries sanctions. Russia exports an average of 8% of the global oil and natural gas resources used by the world. As a result of the loss, prices are expected to rise and remain high until the war is over.
A common phrase used by corporations to justify rising prices is “supply chain issues”. These issues are often ones that are started due to shortages enacted by the COVID pandemic restrictions. The shortage of the workforce during the pandemic and the loss of trade on top of the rising gas prices have contributed to products not being able to be assembled or delivered in time.
First it was toilet paper and lumber, then it was baby formula and gasoline. Now it’s tampon products as well. These items seem to be uncorrelated but essential for daily life. The scarcity of these items are making their prices rise; further escalating the problem of inflation. Unless these products and supply chain issues clear up quickly, it is unlikely that inflation will be going away any time soon.
The economy’s recovery coupled with the ongoing war on Ukraine has moved the US yearly inflation rate to 8.6%. It is widely accepted in economics that the ideal inflation rate should remain at only around 2%. To lower the inflation rate, requires a government response.
US Government Response:
When inflation is high, the Fed does one of its only tricks it has in the book: It raises interest rates. As of July 16, the Fed has announced that the interest rate will rise by 75 percentage points; the highest increase since 1994.
Interest rates have been at near zero levels since 2008. So, while this is the largest interest rate hike the Fed has taken since 1994, this isn’t the highest interest rates have ever been. The highest the rate has ever been was 14.6% in 1980.
What raising interest rates does is it strengthens the value of the US dollar around the world and thereby increases the desire for US dollars for foreign investors. The reasoning is that if the bond interest rates are higher, more investors will want to buy them and therefore want more US dollars.
What occurs is overseas investors selling more goods to Americans to receive more US currency. The problem is that this will in turn increase the trade deficit and throw a considerable amount of people out of work. But, if successful, the economy slowing down will decrease inflation.
The Fed is walking a tightrope of controlling inflation whilst also preventing a recession. Unless the war in Ukraine improves and supply chains are restored, the interest rate hike may not be enough to stop inflation from rising in the future.
This blog post is part of the CIMA Law Group blog. If you are located in Arizona and are seeking legal services, CIMA Law Group specializes in Immigration Law, Criminal Defense, Personal Injury, and Government Relations
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