The silent killer. The redheaded stepchild of economists. Inflation has become a big topic in the financial media recently, as it typically does during periods of government stimulus and spending. However, inflation hasn’t been a real risk for a very long time – even decades – so why is it coming into the conversation now?

Before we go into our expectations for inflation in the near term, let’s first cover the basics. Inflation is traditionally measured by something called the Consumer Price index, or CPI. Over the past 20 years, the CPI has averaged around 2.5%. Before the Great Recession of 2007- 2009, CPI averaged around 2-3%. There was a brief spike to around 5% coming out of the crisis, but it has since hovered around 1.5%. In other words, inflation has been largely muted for a very long time. It’s also worth noting that the CPI formula has been adjusted multiple times to account for changes in consumer culture and to increase efficiencies over the years.

There’s another measure of inflation called Core CPI, which is CPI without food and energy. The reason for taking out those two factors is primarily because those two areas tend to have volatile pricing swings. Taking them out gives us a more stable measure of inflation over time. Looking at that measure, inflation has averaged around 2% for the past two decades.

Another measure of inflation, called CPI-E, is an experimental index for those ages 62 and older. It was created to narrow down the expenditures to those of seniors, whose expenses have historically gone up faster than CPI. It has been argued that this should be the measure used to determine social security cost-of-living-adjustments (or COLAs), but that has not yet been implemented since it would put a larger stress on the social security program. Instead, the CPI-W measure is used, which only includes expenditures by those in hourly wage earning or clerical jobs.

Going back to the original point, if the common consensus is that federal stimulus or spending leads to inflation, then shouldn’t there be a correlation between these two metrics? Well, there’s not. If you look back to the early 1990s, over the time that the federal deficit has increased, inflation has decreased. Not to say that an ever-increasing deficit isn’t a problem, but historically it hasn’t caused inflation.

More simply put, inflation isn’t directly correlated to government spending or an easy dollar, it’s dependent upon supply & demand. If supply is rampant but demand is low, prices tend to decrease. Alternatively, if supply is low and demand is high, prices tend to increase (i.e. companies can charge more for goods and services when there are less goods and services available).

And that’s what we’ve seen with the latest inflation increase. The Walt Street Journal reported that U.S consumer prices surged 4.2% in April, the biggest jump in any 12-month period since 2008. Why is that? Consumers are finally getting out and spending money, however, the supply chain has not yet recovered from the pandemic. That means that demand is there, but the supply is not, which has led to an increase in prices. Theoretically, this shouldn’t last long, as factories and manufacturing facilities get back to normal production levels. Once that happens, supply should get back to normal, and therefore, so should prices.

With that said, although we don’t see rampant inflation becoming an issue in the near-term, we do think it’s crucial to factor inflation into your overall financial plan. Even a 2% inflation rate could have a big impact on your spending plans in the future. For example, the average cost of a new car in 2021 is $39,000. With 2% inflation, after 30 years that same vehicle will cost over $70,000!

At Pathfinder, we have been helping our clients navigate the risks of the markets for decades. Whether it’s inflation, recessions, market volatility, or a global pandemic, we have helped to keep clients grounded and financially confident even during the toughest of times. If you’re looking to partner with a firm that can help you look past the financial headlines, give us a call at 910-793-0616.