Have we reached the peak of inflation?

Has inflation finally peaked? The signs indicate that the answer is yes and that it will continue to decline. So let’s take a closer look at these signs, including what happened and why.

Definition of inflation

Inflation is, quite simply, higher prices. That doesn’t tell us much until we look at why prices are rising. And here, there are two ways to see it. The first is to look at increases in different components (energy, food, goods and services being the main ones) and then conclude that we can understand inflation from these changes. Recently, for example, energy and food prices have risen and pushed up inflation. It’s useful and necessary, but not comprehensive, largely because it’s retrospective. He can tell us what happened, but not why.

The second way to view inflation is to look at the conditions that cause it. This is the monetarist explanation, which focuses on interest rates and money supply. The often-heard quote is that “Inflation is always and everywhere a monetary phenomenon”, by Milton Friedman. This approach is also useful and necessary, but not complete. It tells us why inflation is happening, but not exactly what happened.

3 drivers of inflation

I would say that there are three factors of inflation: variations in supply, variations in demand and monetary variations. The more these factors are present, the higher inflation has been in recent decades. Looking at it this way, not only do we gain explanatory power in the past, but we can also understand what has happened in recent years by tying the two explanations together, along with some theory. More importantly, we can use it to see where we are going.

So how have these three components changed over the past two years? After the pandemic, we had all three inflation generators in play. Demand was on the rise, with the Covid-19 stimulus programs. Supply was down, with supply chain issues. And money was cheap, with zero and negative real interest rates. With all three in force, it’s no wonder we’ve seen an explosion in inflation.

how things have changed

Now things are changing again. For demand, while strong employment has kept demand fairly high, stimulus payments have been spent and real wage growth has been negative, bringing it back to levels six months ago. . Supply chain issues have also largely eased, and even spikes in energy and goods costs have faded. Finally, interest rates have risen sharply, the effects of which are already visible in the housing market. Of the three inflation factors, we have now moved on to perhaps just one, in the form of demand. It’s a big change. What if the theory is correct? We should also see a decline in inflation.

Inflation peaked

The various components of inflation continue to evolve as expected. Going forward, we can reasonably expect inflation to continue to decline, probably between 3 and 4% by the end of next year.

For now, the real takeaway is simply that inflation has peaked here in the United States, and that has many positive implications for the economy and markets.

Carol N. Valencia