in 1955 the average price of a movie ticket was 73 cents. Today, it’s about nine dollars.
This phenomenon, as you probably already know, is called inflation. Simply put, inflation is the increase in prices of goods and services across an economy over time.
It refers to everything you buy from groceries to doctor’s visits to homes. Inflation is among the most powerful forces in the economy and financial markets.
Too much or too little can send the economy spiraling so the inflation rate is a big deal for policymakers and especially the Federal Reserve.
In the past century, inflation rates have become less volatile.
What is our current interest rate?
The fed’s long-stated goal is to keep inflation at about two percent: not too high and not too low. However, now they’re worried the rate drifted below two percent too often and they’re rethinking the strategy.
Before getting too into the strategy change, let’s quickly break down the causes of inflation in the first place.
There’s a lot of debate and few certainties when it comes to what causes inflation, but here are some of the popular theories out there.
Increased demand inflation can occur when there’s an increase in demand for goods and services. All over the economy, from households to businesses, to the government, many factors can drive up demand.
When demand grows faster than supply, businesses can raise their prices. This type of inflation may occur in a growing economy.
Supply pressures can also drive inflation when the cost of doing business goes up. Companies need to raise prices to protect their profit margins.
Higher wages, higher land costs, and even tariffs can all make running a company more expensive and lead to inflation.
What does the Fed do?
The Fed is a major factor in inflation, as it dictates the supply of money in the economy and changes interest rates (the cost of borrowing money).
This affects whether prices go up a lot or a little. When the Fed lowers rates, loans become more attractive to consumers. They borrow more to start businesses, buy cars and homes – and spend more on consumer goods.
This effect drives up demand and increases inflation.
On the flip side, the Fed raises rates to limit demand and keep inflation in check. Typically, if inflation starts to pick up, the Fed considers raising interest rates to limit borrowing. The hope is that this could keep the economy from “overheating” and keep inflation down.
Historically, this has been done 4 times.
As a thought experiment, if inflation began to increase at an alarming rate, what would happen to your consumer confidence? Would you not anticipate an inevitable further increase in inflation?
Such a fear could lead to a period in which wages rise sharply, pushing up business costs and forcing further price increases.
When we look at today’s record-low interest rates, the Fed has less room than in the past to cut rates. Remember, the Fed lowers rates to stimulate growth and keep inflation around that 2% mark. In each of the past three downturns, the Fed lowered the rate roughly five percentage points. Such a move would be impossible with the current interest rates, leaving many to speculate over a particularly scary proposition: Is this the house of cards about to fall?