Defining Inflation

At its core, inflation is simply too many dollars chasing too few goods. Inflation also reduces the purchasing power of each unit of currency, which can lead to an increase in the prices of goods and services over time. Thus, you will spend more to buy a gallon of milk, fill your gas tank, or get a haircut. Although policies have tried to tame inflation for several decades now, it would be best if you paid a little more attention to it. First, inflation affects commodity prices which will affect your daily spending. And from an investment perspective, you need to think about where you allocate your assets and how inflation affects them.  

The M2 Money Velocity

Most financial experts consider the M2 Money Velocity the pulse of the economy. The metric describes the number of times a unit of currency changes hands between individuals and businesses. For example, if the velocity of money increases, more transactions are occurring between people and companies. The number of times money changes hands can be used to determine whether businesses and consumers are saving or spending their money. 

Do You Need to Worry About Inflation? 

Inflation can be an inevitable economic prospect, but more Americans are worried about what could happen if inflation spins out of control. The government has already approved about $3 trillion in financial aid for struggling businesses, families, and unemployed workers since early 2021. The Biden administration is also seeking another $1.9 trillion to help mitigate the effects of the pandemic. These astronomically huge sums coupled with the lowest ever interest rates could trigger scenes only comparable to those seen in the 1970s. Moreover, if the vaccines were effective, we would witness a massive boom in pent-up consumer spending that would likely push for a rise in prices.

The question is whether the projected inflation will be easily managed or lead to a dramatic flood that will stir the markets, cripple savers and force the Federal government to hike rates, thus derailing the recovery. The good news is that many financial experts aren’t anxious that inflation will spiral out of control, especially since the economy has enough post-pandemic ground to make up.

The Role of Price Expectation in Inflation

Most consumers will spend money on a product immediately if they think its price will shoot in the coming months. The reasoning behind this is that consumers believe they can save more money by buying the product or service now rather than later. This rationale can become a self-fulfilling prophecy since consumers spend more and save less; thus, the velocity of money increases, further aiding inflation. However, today’s consumers have ready access to prices of different products allowing them to compare prices one to the next fluidly.