We are now more than halfway through the year and the stock market continues the ascent that began in 2009. One of the most significant events in the quarter was the Federal Reserve’s decision to increase short-term interest rates again. This was an appropriate action given the economy is doing well enough to warrant rates above zero, where the Fed held them between 2008 and 2015. Of the Fed’s two mandates, full employment and stable prices, both are currently hitting their targets.
Around this point in the business cycle, when the unemployment rate is low, one fear that comes up is accelerating inflation. This quarterly commentary focuses on the phenomena of inflation, which famed economist Milton Friedman once described as taxation without legislation.
What is inflation?
On a basic level, inflation is the general rise in prices of goods and services. Inflation is usually mentioned in a negative light, eliciting images of hyperinflation and needing a wheelbarrow full of cash to buy a loaf of bread. A little inflation, however, is considered healthy for an economy, as long as wages are growing too. When inflation gets too high though, it’s a sign the economy is overheating and is usually a precursor to the next downturn. A decline in prices, or deflation, on the surface, sounds good. Who wouldn’t want to pay less for goods and services? The reality is though, that in a deflationary environment, people pull back on spending because they can purchase things at a lower price in the future, which causes the economy to weaken. If people think prices will be higher in the future, it can pull forward spending and spur economic growth. This is why inflation is like Goldilocks, we don’t want it too hot or too cold, but somewhere […]