Imagine, you negotiate a raise at work, feeling a sigh of relief knowing your pay will finally outpace your expenses. But wait, the grocery bill is steeper, gas prices are soaring, and now even your morning coffee feels like a luxury. Did your raise suddenly lose its bite? Welcome to the hidden world of inflation, where prices silently rise, eroding your purchasing power like a phantom tax.
What is Inflation?
Inflation, simply put, is the sustained increase in the general price level of goods and services in an economy, often measured by the Consumer Price Index (CPI)1. Since the start of the pandemic in 2020, the CPI has climbed dramatically, not just reaching a peak of 9.1%2 in June 2022, but cumulatively increasing by over 18% between January 2020 and December 2023.3 This means a product costing $100 in 2020 might set you back $118 today – a noticeable difference that adds up quickly across all your purchases.
But what fuels this price rise? One significant factor is the money supply, which refers to the total amount of money circulating in an economy. Governments can increase the money supply by “printing money,” essentially injecting new cash into the system. This might sound like a quick fix, but it can lead to devaluation of existing currency if the increase outpaces genuine economic growth.
Role of Federal Reserve
In the case of the US, the Federal Reserve (Fed), the central bank of the US, plays a significant role in this process. Since the start of the pandemic, the Fed increased the money supply by a staggering 40%4, aiming to stimulate the economy during the downturn. While this measure may have achieved its immediate goal, it also contributed to the current inflationary pressures.
Risks of Inflation
The risks of excessive money printing are not merely theoretical. Countries like Venezuela, Zimbabwe, and the Weimar Republic in Germany serve as stark reminders of the devastating consequences of runaway inflation.5 The US is not close to the conditions in which these countries experienced HyperInflation, and has unique economic advantages over these countries, however we are not immune. When Money Supply grows faster than Economic Output, inflation follows.6 The massive injection of money by the Fed increases those risks.7 Ratings agency Fitch recently downgraded the US credit rating, meaning they perceive higher risks investing in the US dollar, yet it remains the most stable currency globally.8
Is Inflation a Tax?
So, is inflation a tax? In a traditional sense a tax is an obligatory contribution placed directly on the population, so the simple answer is no. However, “to tax” meaning “to burden, or put strain upon” certainly applies and therefore in a broader sense many argue it is. Governments have two ways to raise money, they can either Raise Taxes or Print Money. Raising taxes is unpopular and for elected officials this is politically risky to have an angry constituent, but Printing Money is indirect, nobody sees it coming out of their pocket but it comes with inflation that is no less real. This “hidden tax” silently reduces the value of your savings and income, impacting everyone from retirees living on fixed budgets to families struggling to afford necessities and whether you are wealthy or poor nobody is immune. Since 2020, wage growth has lagged behind inflation, meaning your paycheck buys less even if the number on it is higher.
Regardless of your perspective, the impact of inflation is undeniable and during periods of high rapid inflation the average American can really see it and feel it. It disproportionately affects lower-income individuals who spend a larger percentage of their income on essentials. While some asset holders might initially gain as investment prices rise, inflation can erode the value of their savings in the long run.
What do you think? Does inflation feel like a stealthy tax impacting your daily life? Do you believe policymakers should prioritize other options over printing money, even if it means less popular decisions like raising taxes?
Ultimately, understanding inflation empowers us to make informed decisions. By keeping the conversation open and questioning the underlying forces at play, we can work towards a more stable and prosperous economic future for all.
Citations:
- Investopedia – How does money supply affect inflation
https://www.investopedia.com/ask/answers/042015/how-does-money-supply-affect-inflation.asp ↩︎ - Wall Street Journal – U.S. Inflation Hits New Four-Decade High of 9.1%
https://www.wsj.com/articles/us-inflation-june-2022-consumer-price-index-11657664129 ↩︎ - Bureau of Labor and Statistics (BLS) CPI Inflation Calculator
https://www.bls.gov/data/inflation_calculator.htm accessed 2/10/24 ↩︎ - Federal Reserve (St. Louis Fed FRED) – M2 and Components
https://fred.stlouisfed.org/series/M2SL ↩︎ - New York Times – Venezuela Hyperinflation
https://www.nytimes.com/2019/02/12/opinion/venezuela-hyperinflation-food-shortages.html ↩︎ - Investopedia – How does money supply affect Inflation
https://www.investopedia.com/ask/answers/042015/how-does-money-supply-affect-inflation.asp ↩︎ - Washington Post – Inflation has Fed critics pointing to spike in money supply
https://www.washingtonpost.com/business/2022/02/06/federal-reserve-inflation-money-supply/ ↩︎ - Reuters – Fitch Cuts US Credit Rating
https://www.reuters.com/markets/us/fitch-cuts-us-governments-aaa-credit-rating-by-one-notch-2023-08-01/ ↩︎
