Inflation: Friend Or Foe?

Probably all of us have thought about the rising prices and how much more expensive life has become in contrast to one or two decades before. No, I am not going to rant about how much better everything was back in the day. Today’s topic is inflation. With the current correction that has hit the global stock indices, seemingly every minute, another article is popping up on news pages about why this decline has hit the indices so hard. Most of the articles link the decline to inflation. According to the Bank of America, the word “inflation” was used 800% more in the current quarterly publications in comparison to last year’s quarterly earnings releases – quite inflationary, isn`t it?! But what is behind this term, and what is linked to it? In this article, I want to sketch the fundamentals of inflation broadly. The term describes a lasting increase in the price level of goods and services. This has different causes and the understanding of it is always linked to our own perspective.

In principle, we need to assume that a capitalistic economic order is based on the idea of the free market. This idea posits that the dynamics of demand and supply interact to achieve so-called market equilibrium. Paired with the concept of private property, an intrinsic motivation emerges for each actor within such an economic system to increase monetary means to afford a better standard of living. That means that supply and demand are subject to constant pressure to grow. The supply side, because the producing actors want to sell more, while the demand side needs to grow as consumers want to consume more quantitatively and qualitatively.

Demand-side factors heavily influence the current situation at the capital markets. The leadership of the biggest economy in the world has poured out 3 stimulus payments to its citizens, while the third one alone has had a volume of over $1.3 trillion, which exceeds the GDP of Saudi Arabia, the Netherlands and Indonesia, respectively. Also other countries paid out stimuli to their citizens or plan on doing so in the near future. In general, it is believed that fiscal measures, such as these payments, will not be saved by the citizens but rather spent and, thus, the money re-enters the economy quickly. As a result, the demand for goods and services increases, while the suppliers of these increase the prices – inflation is the result. Because of the increased income, the investment rate increases, too. Whether the investment comes in the form of increased wages, new machines, software, innovation, or other companies does not matter here. The premise is that more money attracts more money.

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