Economists are always keenly aware of it. The average American? Not so much, generally speaking. What are we referring to? Inflation. A basic tenet of economics that has been a major source of discussion lately. We take no strong stance on whether inflation will be mild or severe, temporary, or long-lasting, but we do feel that it is important to know the ins and outs of this important economic concept.
What is inflation? The dry textbook definition is as stated: a quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. In other words, a bushel of apples cost $4.00 one year ago but cost $5.00 today. Simple, right? We all remember our older relatives lamenting the cost of a candy bar “back in the day.” Little did our 10-year-old selves realize that our grumpy, yet endearing, loved ones were inadvertently explaining inflation.
So, what’s the big deal? Prices have risen over lifetimes and we’re all still able to afford that bushel of apples. Well, generally, an inflation rate of less than 2% is considered healthy in a growing economy. Your wages and investments, usually, grow by more than the inflation rate. The problem is when the prices of goods rise faster than the average person’s ability to keep up.
What actually causes inflation? Inflation is caused by too much money chasing after too few goods. Sound simple? Yes, it really is that simple, even if a multitude of economic factors are at play in the complex global economy. Not enough supply of goods? Too much government stimulus? Low interest rates? It’s impossible to know for sure what causes inflation. Economists argue incessantly over the details. As a consumer, you are much more concerned with more pressing questions.
Are prices rising faster than the usual inflation rate? Yes, they are. But there are many things to consider before panicking. The COVID-19 shutdowns and the subsequent government stimulus programs have created an unusual economic environment. As things return to normal, the effects of these two variables are likely to subside. Another factor to consider is inflation has been very, very low for decades. Many Americans, especially younger ones, do not remember a time in which inflation was a serious factor in their financial lives. The late 1970’s and early 1980’s was the most recent era of relatively high inflation. As a result, many working Americans might react strongly to even mild inflationary trends. They simply do not have any experience with these trends. The unusual economic environment of the past 14 months, plus a lack of a historical perspective, might be creating unnecessary alarm among many Americans.
So, what should you do? From a short-term spending standpoint, rising prices are somewhat inevitable. Your car still needs filled up and your refrigerator needs restocked. But taking a long-term perspective, any negative effects from inflation will likely be mild. The asset allocation we have constructed for your retirement portfolio is designed for multiple economic environments, including one with high inflation. Remaining a well-disciplined investor, focused on the long-term, is the best approach to inflation.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice. Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s clients.