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 Market Mysteries of the week

  Why is everyone worried about inflation? 

Answer They’re worried that if inflation keeps rising faster than expected, that the Federal Reserve will have to quickly switch from stimulating mode to restricting mode much sooner than expected.What is inflation?Inflation is the rate at which our dollars lose purchasing power. It’s the reason a bottle of coke no longer costs 25 cents. It can be caused by a number of factors, including more dollars added into circulation (stimulus), fewer available resources (increasing wages to attract workers), or buyer demand overwhelming production (supply shortages).Right now, prices are increasing all over the place. Consumers are ready to spend, but businesses aren’t fully back up to speed yet. So we’re seeing shortages of supplies and sellers increasing prices. We’re also seeing an influx of stimulus from the Central Bank and from US Government spending, adding more dollars to the pool buying the same amount of stuff. Is inflation bad?Not inherently. Low inflation is a totally normal part of a healthy economy. If it were going the other way, and the purchasing power of our dollars increased the longer we waited, we’d be incentivized not to spend. Less spending isn’t good for the economy. What people are worried about is inflation getting too high, and prices increasing too quickly. That would be an indication that there is way too much lending and spending going on out there for the given available resources.What happens if inflation gets too high?The Federal Reserve, aka the Central Bank, controls the flow of money. Their job is to keep the economy running warm, but not let it get too hot. Inflation is the main indicator of that heat level, and they're targeting about 2% annual inflation. They reduce interest rates and print new money when the economy is in trouble, to stimulate economic activity and make sure it’s really easy for everyone to do what they need. This can cause inflation to rise. Businesses take out low-cost loans and expand production, and consumers can refinance their mortgages and spend more.When the economy runs too hot, the Fed starts increasing interest rates and reducing the money supply to try to slow things down, reducing inflation. Higher interest rates means your mortgage, auto loan, student loan, and credit card payments could all go up. High costs of debt can eat into corporate profits and limit their growth.The Fed is the host of the party, handing out plenty of drinks early on to get people on the dance floor. At some point they read the room and start handing out waters. Investors are worried they might be handed a water soon.Should I be worried?Not just yet. The Fed isn’t worried. Neither is the White House.The May inflation report released Thursday showed prices rising faster than expected, but the stock market still went up. That means despite prices rising by the fastest rate since the 2008 crisis, investors didn't think the report was bad enough to cause the Fed to change policy.The Fed says these price increases throughout the economy are mostly “transitory”, meaning as we move further back to normal, more people return to work, and businesses get production back to normal, much of these pressures will release.That being said, the Fed has been wrong about inflation before. Higher inflation is definitely a legitimate concern, but the reality is no one knows what will happen. Bad scenarios include a rapid spike in inflation that forces the Fed to raise interest rates and cut off the economic expansion, destabilizing growth and potentially leading to companies and people defaulting on debt.Last year was unprecedented for many reasons. The global economy has never had to completely shut down and then restart, so some turbulence on the reboot seems reasonable.Also, the stimulus spending from the government and support from the Fed has been larger than we’ve ever seen. No one knows exactly what happens when there’s that much money added to the system.All that to say, we’re a long way from total economic collapse, and we’ll be sure to keep you updated if we see any signs of that on the horizon. For now, just keep doing you and sending us any questions you have.💙 The Scoop Team

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