Common Misconceptions About Inflation

Common Misconceptions About Inflation

May 03, 2024

The primary cause of inflation is an increase in the money supply. It is generally measured in one of two ways: by analyzing the consumer price index (CPI) calculated by the Bureau of Labor Statistics (BLS) and the personal consumption expenditures (PCE) price index from the Bureau of Economic Analysis (BEA). The most popular way is to review how the CPI measures the price changes experienced by U.S. consumers across a period of time.

According to Michael Bryan, vice president and senior economist in the Research Department of the Federal Reserve Bank of Atlanta, the word inflation is somewhat misunderstood today. It originally described currency and money, not prices. Nowadays, the term inflation gets thrown around often, along with several myths about it. In this blog, we want to bust a few of those myths.

Myth # 1 – Higher wages cause inflation

Labor shortages throughout the economy help drive up wages. Businesses are forced to pay for more labor, which results in price hikes that burden the consumer. Increasing wages is, in fact, a symptom rather than a cause of inflation.

Myth # 2 – Increased prices create inflation

Prices rise over time, and this doesn’t only involve periods of inflation. It also occurs during times of low or no inflation. Instead, like wages, they are a symptom of inflation rather than a cause. The Federal Reserve Bank of St. Louis uses a model to give this concept context. Say you have a basket of cookies worth $2. You have an Oreo for $1 and a chocolate chip for $1. Let’s imagine the Oreo’s price decreases to 50 cents while the chocolate chip cookie increases to $1.50. The prices changed, but the general price level remained constant at $2; therefore, there was no inflation.

However, in this scenario, the relative prices have indeed changed. As a result, consumers may choose to alter their purchasing behavior, perhaps favoring Oreos over chocolate chip cookies. This shift in consumer choice demonstrates the power and control individuals have in response to price changes.

Myth #3 – Once inflation goes down, the cost of goods and services will be cheaper

Unfortunately, it is commonly misunderstood that decreasing the inflation rate includes the immediate lowering of prices. There is not necessarily a direct correlation between the two. Prices of some goods and services may decline slower due to, for example, supplier contracts that set prices months in advance. 

Myth # 4 – Politics and government spending are the cause of inflation

According to Forbes, economists have historically agreed that the link between government spending and inflation is weak. In reality, the drivers of inflation vary depending on who you ask. They can be a combination of factors, potentially including supply chain disruptions, fears of the financial repercussions from wars, energy shortages, an uncertain housing market, and more. It is fairly safe to argue that politics and government spending may contribute to a rise in inflation, but they aren’t the sole cause.

Myth # 5 – Skyrocketing oil prices are causing the inflation

Anyone who regularly drives a vehicle scoffs when they have to fill up and notices the oil prices are soaring once again. Immediately, they blame oil for the high inflation, which continues to plague our wallets and our patience. However, a rise in the oil price only contributes to inflation. It is not the cause of it. Part of the steeper prices at the gas pumps stems from several factors, including, fears of supply disruptions due to global conflicts.

Consult your financial professional

When it comes to finance and creating financial strategies and goals, it can become highly complex, with many nuances and a constantly evolving financial landscape that may or may not impact you. Consulting a financial professional may help you in a variety of ways, from debunking certain myths, working to mitigate unforeseen market risk, and learning how to manage your portfolio and investments in a volatile market. It may also be beneficial to have your young adult children meet with a financial professional, particularly in uncertain times, to lay the foundation for preserving generational wealth and the acquiring of money management skills.

 


Important Disclosures:

Content in this material is for educational and general information only and not intended to provide specific advice or recommendations for any individual.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.


Sources:

How Inflation and Relative Price Increases Differ | St. Louis Fed (stlouisfed.org)

Inflation is cooling, but high prices will stick around (cnbc.com)

Yes, inflation is coming down. That doesn’t mean goods and services will be cheaper | CNN Business

Debunking 6 Inflation Myths (forbes.com)

Does Government Spending Cause Inflation? (forbes.com)

 

This article was prepared by LPL Marketing Solutions

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