Inflation Is Not a Four-Letter Word
Inflation has returned to the public’s consciousness so let’s talk about what it is and whether you should be concerned. In my next blog, I will tackle what you might want to do with your investment strategy during times of increasing inflation.
The General Idea
Inflation is simply the increasing cost of goods and services, and it is generally caused by increasing demand in the market without a sufficient increase in supply. Over time, it has been an accepted part of economic life that prices will go up over time, but more recently we have become numb to this concept due to a sustained period of minimal inflation in recent years. Depending on the time period you use, inflation has averaged 3-4% historically, but over the last few years it has been closer to 1%. Now, suddenly, we are seeing inflation rates spike back up again to 5% or more.
Is Inflation Bad?
Unlike some economic metrics like GDP growth or unemployment, it is less clear whether an increase in inflation is a good or a bad thing. At the extreme, runaway hyperinflation of 50% more per year is extremely destructive to an economy, as evidenced in real-world examples like post-WWI Germany or post-WWII Hungary, or more recent examples like Venezuela today. But at the margin, a smaller increase in inflation could be either a warning sign or just a symptom of strong economic growth. So, inflation should be viewed in the context of the overall economic picture by looking at factors like economic growth and employment data to determine whether it is having a positive, negative, or neutral impact. Right now, as an example, we have very low unemployment and solid economic growth.
Is Inflation Transitory?
There has been some concern and confusion over whether the most recent levels of higher inflation are going to be continuing or transitory. On one hand, there are some aspects of the recent inflation increase that are unlikely to continue at the same rate including the current supply chain issues as well as the recent spike in oil prices. However, the shortage of workers in key sectors and the resulting upward pressure on wages do seem like a new and continuing trend so we are unlikely to go back down to the 1% inflation levels of 2018-2020 any time soon. So, the economists that I trust are indicating that inflation will subside somewhat from the most recent numbers, but that it will stay higher than recent years and instead be closer to historical averages. My conclusion is that inflation is real, but it’s not necessarily a bad thing all by itself so it’s not a reason to panic. In my next blog, we will talk about what to do about inflation in your investment portfolio.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Neil Manning, CFP, AIF, CDFA, FSA
I am a reformed actuary turned financial advisor, helping my clients with everything from investments to retirement projections to LTC insurance since 2014. Unlike most normal people, I love numbers and finance – I’m currently reading a book about game theory which my wife and two teenage daughters think is unbelievably boring (they are wrong). For more details about my background, check out my website below.