There’s been a lot of talk in the media lately of inflation roaring back.
Lots of us millennials don’t know what it’s like to live through inflation. We’re products of the 2008 financial crisis which has seen more than a decade of record-low interest rates and little to no inflation. However, speak to your parents about the 70’s and 80’s and you’ll find a time where interest rates were 10%+ and price inflation was 10% or more a year.
There are two kinds of inflation.
One results from demand growing faster than the economy’s productive capacity, causing the economy to overheat. Call that good inflation, because it’s usually linked to a stronger economy. By contrast, bad inflation results from constricted supply which curtails output, driving up prices and eroding incomes, leading to a weaker economy.
Price inflation can be plotted on a supply and demand curve to illustrate.
Let’s take fitness equipment selling on Amazon during the start of the Lockdown. Overnight demand for home fitness equipment boomed, moving the demand curve plotted in red to the right and pushing up the price. (The price is set where demand meets supply).
The above chart shows why the price for kettlebells skyrocketed!
So what about the supply curve in green. Well, let’s take the same example during lockdown and say that all the Chinese factories producing the fitness equipment shut down for six months while lockdowns were imposed there.
Supply reduces and the supply curve in green moves to the left.
Here we have a double whammy. Prices going up due to increased demand at the same time as there is pressure on the supply side to produce goods. Causing price inflation.