By Brian Gold

THE BRIEF

Inflation refers to the rate at which the general level of prices for goods and services rises, causing purchasing power to fall. The term "inflation" originates from the Latin word "inflatio," which means "to blow up or inflate." Historically, it denoted the action of inflating something with air. The contemporary economic context, referring to the "inflation" of prices, emerged in the late 19th to early 20th century. 

BACKGROUND

If interest is the price of time, inflation is the burn rate of money. Interest rates are set by the Federal Reserve for various reasons. They might increase rates to combat inflation or decrease the policy rate to stimulate borrowing, spending, and investment, which can boost economic activity. 

After the financial crash of 08' the Federal Reserve of the United States set interest rates at near zero for over a decade. Over the years, this has produced the effect of "easy money," making credit and lending activity cheap. That was mistake one. When the economy bottomed out by 2012, that's when the federal reserve should have steadily increased interest rates. Healthy rates of inflation at 2% are actually good for the overall economy. 

Instead we created what is now known as a "low interest rate environment" where the economic business models that relied on low interest rates no longer pencil out. Interest rates is in this regard is like gravity and modulates the velocity of money. 

And in response to the pandemic the Central Bank decided to increase the money supply by over 40%. This spiked the value of assets like stocks, IP, private equity, and real estate, while decreasing the value of the dollar. 

ANALYSIS

Where are we now? 

There has never been a time where unemployment was below 4%, yet inflation is above 4% without the economy going into a recession. Today, even though we have low unemployment and the stock market has done surprisingly well over the last year, most Americans don't feel that great about the economy. 

Outlets have been posing questions like: 

Why Aren't Americans Happier About the Economy?

If the Economic Statistics are Good, Why Do Americans Feel So Bad?

Why Are Americans So Negative About the Economy?

Shawn Strzepek has modeled why we might feel this way by mapping the Consumer Price Index (CPI), an indicator of inflation, with the unemployment rate, and our disposable income. 

His model, represented by a gray plane, visualizes our how we feel about the economy. You can play with his model here.  

TAKEAWAY

Americans feel this way about the economy because of their decreased purchasing power. While inflation is a significant factor, an under reported metric that deserves more attention than the market indexes or our country's GDP is real disposable income.

Real disposable income represents the amount left after adjusting for taxes and inflation. It's an indicator of our spending power, revealing how far we think our money can go. 

In 2022 it saw its largest decline, a drop of 6.2%, from the previous year. That's the largest year-to-year decline since they started collecting the data in 1996. 

Inflation is not inherently bad, and a can be healthy in moderation, but as Milton Friedman once said, "Inflation is the most destructive disease known to modern societies. There is nothing which will destroy a society so thoroughly and so fully as letting inflation run riot."

The jury is still out on whether the Central Banks can get inflation under control and stabilize the economy after years of setting interest rates too low while printing an unprecedented amount of money into the system. 

A good monetary policy would ideally increase interest rates when times are good, and decrease interest rates when times are bad based on market cycles. Our Central Banks did neither, and have pulled all the levers without understanding the long-term effects of their actions. Now, as we face the repercussions of these decisions, we are all in the position of navigating uncharted waters. With unpredictable currents, everyone is proceeding with caution. 

— Brian Gold is the Editor and Founder of Good Monsters Inc.