Inflation might well be regarded as Public Enemy No. 1 given its widespread impact on consumers.

Our country’s most recent experience with elevated inflation began in early 2021, peaking at over 8.5% in March 2022.

The Federal Reserve’s initial reaction was to describe inflation early in 2021 as “transitory,” thinking the COVID-19 pandemic-induced price surges would be temporary, and told Americans not to worry.

But later that year, the Fed was forced to confront really high inflation that our country had not experienced in decades.

Between March 2022 and July 2023, the Fed raised interest rates 11 times to combat inflation.

You might recall that the Fed was continuing to hold the federal funds rate at around zero in the first quarter of 2022 — and still buying billions of dollars of bonds every month to stimulate the economy.

Understanding Inflation

Economists describe inflation as “a gradual loss of purchasing power, reflected in a broad rise in prices for goods and services over time.” The inflation rate is calculated as the average price increase as a basket of selected goods and services over one year.

While there are several ways to measure inflation, the two most widely followed are the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) index.

The Fed’s preferred measure is the PCEX, which leaves out volatile food and energy prices.

Regardless of which index you prefer, the fact is that consumers have been feeling the pinch of higher prices.

Here are some examples over just the past five years (between 2019 and 2024), according to the U.S. Bureau of Labor Statistics:

• 1 gallon of fresh whole milk +24.85%
• A loaf of bread +29.39%
• Fresh whole chicken +30.99%
• Gasoline (all types) +28.54%

In general, prices for food and beverages are up +26% over the past five years.

But a longer look back tells an even more startling story with prices for food and beverages up +486% since 1974.

And the price for gasoline (all types) is up +606% over the past 50 years.

Even more startling is the median price of housing, which is up +972% since 1974. For Santa Barbara, the median home price was $145,000 in 1981, and is now a whopping $2.5 million. No wonder it is so difficult to afford to live in the Santa Barbara area.

But there are other parts of the world that have experienced hyper-inflation over the years. As of December 2023, Venezuela was experiencing the world’s highest inflation rate at more than 200%.

Winners and Losers

As with most things in life, there are winners and losers during inflationary times.

Typical winners include borrowers with existing fixed-rate loans (some of you have mortgages under 3%), the energy industry and companies that are able to pass along cost increases. 

Losers are folks on a fixed salary or fixed income along with renters and those living paycheck to paycheck where rising prices really hurt.

So, what causes inflation? While this is a remarkably complex issue with lots of nuances, an increase in the supply of money is the root of inflation. More money is chasing goods and services with supplies that don’t increase as rapidly.

People having more money leads to higher spending, which pulls prices higher.

Since January 2020, the money supply (M2) grew by $4.6trillion, or 24%. Since 2009, more than $12 trillion of the current money supply has been created.

Federal Reserve’s Response

The Federal Reserve and U.S. Treasury have been very busy over two critical economic periods: the Great Recession (2007-2009) and “the great pandemic” (2020-2022) as you can see from the following chart showing the Federal Reserve’s balance sheet. Note the spike in 2008 and the even more dramatic spike in 2020.

The following chart — an Econsnapshot from Peter Rupert of the UC Santa Barbara Department of Economics.

The combination of dramatic increase in money supply (more than doubling) during the COVID-19 pandemic and supply-chain restriction are clearly causes of the inflation that followed.

Pretty simple economics: lots of new money causing increased spending for decreased supply of goods and services. This should be no surprise.

In response, the Fed has been “tightening” by raising interest rates and slowly reducing its balance sheet — while trying to avoid sending the economy into recession.

The rate of inflation fell in response to higher interest rates, and financial markets anticipated up to seven rate cuts in 2024 thinking the battle had been won.

I personally thought that was way too optimistic, and the Fed recently noted that inflation has remained “stubbornly high” and doesn’t anticipate rate cuts until it has “greater confidence” that price increases are slowing to its 2% target.

Hopes for a “soft-landing” (beating inflation while not pushing the economy into recession) remain — but only time will tell.

Meanwhile, trips to the grocery store (and other spending) will continue to be more expensive.