Inflation
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The Federal Reserve has begun to raise interest rates — in the hope of cooling off the economy — to slow inflation.

You have noticed that prices are going up. Gasoline at the pump, fruits and vegetable at the supermarket, and more or less all other products, suddenly cost more money. That is inflation. 

What impact does inflation have on producers?

Melina Bronfin
Melina Bronfin

Melina Bronfin, a master gardener and herbalist, has a small business, Sunny Squirrel Farm LLC, selling garden plants, houseplants, syrups, salves and craft items on the internet and from her home in Oak Park. Inflation has an impact even on this little business. Her material costs have gone up, and the cost of fuel to get the material has gone up. 

Bronfin says, “I had to start by raising my prices a bit due to higher material costs.” But she has to take care not to make prices too high. She observes that “my customers have the same problems.” 

Rising prices can extinguish demand. If the price gets high, people can decide to do without.  

Other producers, though, can raise prices without much fear that people will stop buying. People need to heat their homes and drive to work. On those expenses, people cannot cut back much. So, when petroleum producers pay more for limited supplies of oil, they charge more for heating oil and gasoline. They now record record-breaking profits. Inflation has winners and losers.  

What impact does inflation have on consumers? 

Holly Eliot of Ann Arbor says she copes with inflation “the same as we’ve always done — buying as little as possible.” 

Most people living on a fixed income, though, have little ability to buy less. They typically spend on pressing items like food, clothing, shelter and basic transportation. 

Eleanor Aharoni and her husband, both therapists, planned and carefully budgeted for their retirement in Farmington Hills. The unexpected recent surge in inflation leaves her “devastated.”

“Being on a fixed income,” she says, “has challenged our budget, including buying food, travel, lifestyle and hopes for the future. All of this has changed.”

Causes Of Inflation 

Retired teacher Gilbert Sniderman, asked about how he deals with inflation, prefers to explain the causes of inflation. He begins with the Russian invasion of Ukraine. 

Gilbert Sniderman
Gilbert Sniderman

The Russians have effectively blocked exports from Ukraine, one of the world’s largest producers of wheat, barley and sunflower oil; the war has also limited exports from Russia itself, a major exporter of these foodstuffs. With a diminished supply of food and the continued demand for food, the price of food must rise. 

As a result of the invasion, many countries are trying to wean themselves off Russian petroleum products. Other petroleum producers — corporations and countries — have not replaced much of that oil. The need for oil remains, so the price rises. Higher fuel costs also drive up the prices of everything shipped. 

Sniderman refers to Tom Stevenson’s article, “Not War Alone,” which appeared in the May 12 London Review of Books. Stevenson notes that the price of grain and of oil increased well before the invasion began. When it looks profitable to keep supplies short, producers keep the supply short. Investors who speculate on anticipated price changes arguably make those fluctuations so much greater. 

The COVID 19 pandemic, and efforts at restricting commerce to limit the spread of the disease, resulted in economic disruption around the world. Supply chains do not neatly recover from disruption. 

Sniderman points to another factor that drives prices up: A small number of giant corporations control the supply of one commodity after another, from baby formula to computer chips. In markets with many suppliers, free market competition should theoretically keep prices in check. In markets controlled by a few players — called oligopolies — the leading corporations can easily collude to raise prices.

Dr. Alan Reinstein
Dr. Alan Reinstein

Dr. Alan Reinstein, CPA, George R. Husband Professor of Accounting at Wayne State University, identifies an additional factor, specific to the United States: deficit spending. 

“For an extended period of time” Reinstein observes, “under both Democratic and Republican administrations,” the government has spent far more money than it has taken in in taxes.  

“The Federal Reserve (the Fed) increases the money supply to fuel deficit spending, feeding inflation,” Reinstein adds. Because, by definition, “inflation occurs when too much money chases too few goods, thus raising prices,” the increasing money supply generates inflation.   

All these factors made inflation inevitable, but Reinstein notes that inflation and recession are simply characteristics of capitalism: “Boom and bust cycles have recurred throughout history.” 

What Should Investors Expect?

In the past few decades, the Fed has kept interest rates unusually low. Bonds and bank accounts were, consequently, not attractive investments. Reasonably enough, as Reinstein notes, “Investors receiving small returns on their bonds often move funds to stocks.” Persistent low interest rates thus helped fuel dramatic rises in the stock market.  

But now, the Fed has begun raising interest rates. In Reinstein’s view, “Bond holders may experience higher interest income as interest rates rise, but often interest rate rises lag inflation rates, so the costs of inflation are only partially offset.”

After a long bull market — stock prices rising year after year — we may now see declining share values. 

Reinstein notes the predictable impact of rising interest rates on the real estate market.

“Higher interest rates predictably will also dampen demand for new residential construction,” he said. “And higher interest rates will reduce demand for existing housing, which, in turn, will cause a decline in existing home prices. Thus, an increasing number of homeowners will find themselves ‘under-water’ with home mortgages exceeding home values.”

High gas prices at the pump.
Close up of a Mobil Gas Station sign showing the high cost of gas in Los Angeles, CA. iStock/Getty Images
What Should Consumers Expect?

Though inflation stresses people on fixed income or on limited salary, Reinstein observes that some workers may come out ahead. “Inflation can inequitably benefit some workers who can demand higher salaries,” he said. 

Inflation may also benefit those who owe money, and can, in Reinstein’s words, “pay off their debts with inflation-ravaged, lower-value dollars.”

Dangers Ahead? 

The Fed has begun to raise interest rates — in the hope of cooling off the economy — to slow inflation. Businesses, unable to get inexpensive loans, may cut back on plans to expand. Consumers, unable to finance purchases, may cut back on spending. This course has a serious danger: We may get, not just a cooler economy, but a cold one, a recession.  If people continue to expect prices to rise, we may even still have inflation, the dreaded combination of rising prices and rising unemployment called stagflation. 

Other countries may anticipate worse. 

Stevenson lists the countries that traditionally depend on imported grain from Ukraine and Russia, including Egypt, Tunisia, Lebanon, Afghanistan, Laos and Sudan. Drought conditions in recent years have made several of these countries even more dependent; climate scientists anticipate worsening drought. Most of these countries, according to Stevenson, do not have cash reserves to purchase food staples to feed their populace. 

Throughout history, the prospect of widespread hunger inspires political unrest, revolutions and mass immigration. 

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