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What is Inflation?

What is inflation?

Inflation is the rate at which the cost of goods and services rises over time. When inflation is high, we experience a loss in buying power because each $1 buys less than it used to.

Inflation is reported by the Bureau of Labor Statistics which tracks two main data points:

  • Consumer Price Index (CPI) which is inflation experienced by consumers.
  • Producer Price Index (PPI) which is inflation experienced by producers.

The main difference between CPI and PPI is that the CPI tracks the prices of goods and services while the PPI tracks the prices of raw materials that are used to make goods.

There are two primary types of inflation that investors should be aware of — demand pull inflation and cost push inflation.

Demand pull inflation

Demand pull inflation occurs when the demand for goods and services is greater than what is available. When this happens and the supply of those goods and services remains the same, the greater demand can pull the prices of those goods and services much higher.

Cost push inflation

Cost push inflation occurs when the price of goods and services increases due to the rising cost of production, which may also limit the amount of goods that can be made. Under this type of inflation, when demand is unchanged but supply costs rise, the price moves higher because producers have to pass along their higher production costs to consumers. If they don’t, they wouldn’t be able to cover their cost of production.

Is all inflation bad?

Of course, many new investors might think that all inflation is bad. However, some low levels of inflation are typically viewed as healthy for the economy. In fact, that is why the Federal Reserve (the bank that sets policy to encourage employment and manages short-term interest rates for the United States) works to target an inflation rate of around 2%. At this level of inflation consumers are incentivized to spend and employers are incentivized to hire more workers. If however, inflation runs significantly higher than this 2% average target, it can cause spending to stop and create economic contractions.

United States Inflation Rate 1960-2020

The last time we faced an inflationary environment in the United States marked by inflation rates of nearly 6% was in the early 1990’s. The best performing investments during an inflationary environment might include a mix of any of the following:

  1. Real Estate
  2. Infrastructure
  3. Commodities
  4. Precious Metals like Silver and Gold
  5. Stocks
  6. Treasury Inflation Protected Securities (TIPS)

Luckily for investors, it is possible to buy these investments in public stock markets. However, it is always important to be diligent about which investments to select because each has their own benefits and drawbacks.

At Metas Investments, we manage portfolios to provide our clients with exposure that we believe will do well despite the economic environment ahead. If this is something you would like help with, get in touch with us.

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