I recently received the following question from Zimbabwe. Question: What is the Impact of Inflation on Financial Services Performance? B. Sibanda Zimbabwe Dear Mr. Sibanda , The most obvious effect of inflation on financial services is that an investment has to perform that much better just to remain even. For instance, under normal circumstances 10% is considered a good rate of return. However, if inflation is 100% and you only earn 10% you have not made any money you have actually lost 45% of your purchasing power. The calculations are as follows: … [Read more...]
Money Supply and the Inflation Rate
Dear Editor, I found your web site as I was doing some in depth research on inflation. In looking at the CPI published by the Federal Reserve Bank of Minneapolis you'll notice three columns. The column on the right shows the "Annual Percent Change (Rate of Inflation)" which appears to be the one you publish on your web site. However, if you do the math and take the years 2006 & 2007 as an example, you'll see that in 2006 the CPI (center column) was 201.6. If you then add 2.9% (right column) you get 207.3 (center column) for 2007. The column on the right merely reflects the percentage of change over the previous year and is not the true inflation we're having. According to the … [Read more...]
What is Core Inflation and Why Doesn’t It Include Food and Energy?
Updated 12/11/2021 I frequently receive this question in one form or another: Why doesn't the government consider food and energy and just tracks core inflation? The core inflation rate is frequently quoted in the popular press, and this gives the general public the impression that the "government" doesn't care about (or track) the rise in the prices of food and energy. Actually, this isn't true. The core inflation rate is simply a component of the overall inflation rate. Economists use it because seasonal factors often skew the inflation rate. For instance, a drought might cause fruit crops to fail, causing fruit prices to rise. But this rise actually has nothing to do with … [Read more...]
Oil and Price Inflation
I recently received the following question from a student in Malaysia. I thought it was a good question so I am including it here. Dear Sir, Greetings, I am a student of International Islamic School Malaysia, Kuala Lumpur. I hope you are well. I am in grade 10 and I take business studies as one of my subjects. Recently I had a class on inflation in my school. The teacher said when fuel prices alone rises we cannot term that as inflation. I disagree with that because I think that rising fuel price is the only exception where we can say that it is inflation. When fuel prices increase the price of all other commodities increase ... please tell me if it is right or wrong to say that … [Read more...]
How does the “Falling Dollar” and the exchange rate affect Inflation?
With all the recent talk about the "falling dollar" will that affect the inflation rate? Let's start with the basics. 1) Price inflation is primarily caused by monetary inflation. In other words as the money supply increases things cost more. See What is Inflation? for a full explanation. 2) The government controls the money supply to a certain extent through tightening or loosening credit. 3) The economy is extremely complex and many other factors come into play. Such as international exchange and the supply and demand for goods and services. At first blush it might appear that the falling dollar would cause deflation because the dollar is going down. But if the dollar is … [Read more...]
Define Inflation: What is Inflation?
What Is the Real Inflation Rate?
I recently received the following question: Please explain to me how my cost of living can increase by 10-15 percent, grocery bills, fuel, energy, clothing, etc. yet my income only increases about 2-3% which typically matches inflation. I have talked to many people about this and a lot of folks feel the same way, how can inflation only be 2-3% when the cost of living keeps going up 4-5 times that number. I am a college student, but only in my first few years so please explain this in basic terms so that I may understand. Thank you tremendously, Jessica This is a common question-- often, it is phrased as "What is the real inflation rate? Who do I believe?" … [Read more...]
Who Does Inflation Hurt Most?
Who does inflation help and who does inflation hurt? When we first think of inflation we assume that it will affect all people equally. After all if everyone is using the same dollars wouldn't everyone be affected equally? The fact of course is that everyone isn't affected equally. Our second assumption might be that the poor would be hurt the worst because they earn minimum wage and everything they buy is getting more expensive. However, if the minimum wage is indexed to inflation they would about break even. So interestingly if the minimum wage earners are also deep in debt inflation actually helps them. The reason for this is that debtors borrow valuable money and the number of … [Read more...]
Bureau of Labor Statistics Changes CPI
The Bureau of Labor Statistics (BLS) made changes of historical proportions this month by changing how the Consumer Price Index is reported. For the first time in history the BLS has begun reporting the Consumer Price Index to three decimal points. Their official statement is as follows: "Effective with this release, index levels are now published to three decimal places. Percent changes based on these three-decimal place indexes will continue to be published to one decimal place. " So for January 2007 the CPI-U index is now 202.416 rather than 202.4 but their official inflation rate is still 2.1% rather than the 2.08% that we calculate it out to. While I applaud the higher level … [Read more...]
Inflation Rises — But no one notices?
In October 2006 the annual inflation rate (CPI-U) was 1.31% and it was 50% higher at 1.97% in November. Yet on the same day the data was released Yahoo Financial News reported in an article entitled "Stocks Rise on Inflation Data"that Inflation was flat. Their exact words were "The Labor Department said consumer prices were flat in November rather than up 0.2 percent as analysts had expected. Core inflation, which excludes volatile food and energy costs, was also unchanged." How can a 50% increase in the inflation rate be considered "flat"? … [Read more...]
