INFLATION

Inflation is the rate of increase in the price of goods and services in an economy. News about inflation has dominated the media as prices hit their highest level in 40 years.

While rising prices of everyday goods are the most common type of inflation , there are other forms as well. Here’s a look at the three types of inflation and major factors that affect each type are examined.

Monetary Inflation :

Monetary inflation occurs when the money supply increases over time. It represents the physical and digital money that circulates in the economy, including cash, checking accounts, and money market mutual funds. The central banks, usually by printing money Buying bonds or changing bank reserve requirements affects the money supply. The central bank controls the money supply to stimulate the economy or regulate inflation and keep prices stable. Between 2021-2020, money supply increased by almost 25% in response to the Corona crisis; it's historical record.

Since then, the Fed has begun to taper its bond purchases as signs of the economy picking up. It is worth noting that, in theory, an increase in the money supply faster than real output growth may cause consumer price inflation, especially if the velocity of money (the velocity of money exchange) is high.That's because there's more money looking for the same number of goods, and this ultimately leads to higher prices.

Consumer Price Inflation:

Consumer price inflation occurs when the price of goods and services increases. It is usually measured by the Consumer Price Index (CPI), which shows the average increase in the price of a basket of goods such as food, clothing, and housing.Supply chain issues, geopolitical events, money supply and consumer demand may affect consumer price inflation. With an increase of 8.6 percent in May compared to the same period last year, the CPI reached its highest level in the last four decades. Russia's invasion of Ukraine and Corona caused widespread disruption in the supply chain, from oil to wheat, it has led to increased price pressure around the world. When consumer price inflation becomes excessive, the central bank may raise interest rates to reduce spending and allow prices to fall.

Asset-Price Inflation:

Asset price inflation shows the increase in the price of stocks, bonds, real estate, etc. over time. While there are several ways to show asset price inflation, the most commonly used is household net worth as a percentage of GDP.

Low interest rates often create a favorable environment for asset prices. This can be seen in the past decade as low borrowing costs have been met with rising asset prices and investor confidence. In 2021, household net worth as a percentage of GDP reached 620 percent.Sometimes rising asset prices can be a misleading sign of a strengthening economy because real production is not occurring. Instead, this may indicate an asset bubble.

The effect of different types of inflation With monetary inflation, businesses and consumers have more money at their disposal, which can increase demand and increase inflation throughout the economy. However, the extent of this impact on consumer price inflation can be uncertain. In the last decade, the money supply increased but inflation did Consumer prices remained relatively stable. Instead, the supply shocks seen with the coronavirus and the attack on Ukraine have had a more immediate impact. The effect of this shortage in goods has made prices more sensitive to demand ,this can be seen with the price of gasoline at the highest level.When it comes to asset price inflation, a significant increase in the money supply and low interest rates are among the likely drivers of rising asset prices.
Since the Federal Reserve will adopt a more stringent stance on monetary policies, asset price inflation will be observed in the future.