Macro Mondays: The Inflation Rate

One of the most widely used measurements of economic health is the rate of inflation, which is not the speed at which a balloon is being blown up -- it's an economic term used to determine the true value of a nation's currency (or legal tender).

For this week's edition of Macro Monday, we will take a look at the inflation rate in the United States and what this implies going forward. More data can be found at Investopedia and Trading Economics.

So What Is Inflation?

Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly.

As a result of inflation, the purchasing power of a unit of currency falls. For example, if the inflation rate is 2.0%, then a pack of gum that costs $1.00 in a given year will cost $1.02 the next year. As goods and services require more money to purchase, the implicit value of that money falls.

The Federal Reserve uses core inflation data, which excludes volatile industries such as food and energy prices -- because their prices change constantly depending on environmental and geopolitical factors. Since these external factors can influence prices on these types of goods, the non-core reading does not necessarily reflect the overall rate of inflation. Removing these industries from inflation data paints a much more accurate picture of the state of inflation.

Below is a great visual demonstration about how the value of a dollar has dwindled in recent decades. So, in 1972, $20 would buy you an entire cart of groceries, in 1992, about half a cart of groceries, and in 2012 you were lucky to be able to purchase a few items, all for the same numerical amount of money. Inflation is a very important issue for economic purposes.

So where are we now?

At the end of 2016, consumer prices in the United States increased 2.1% year-on-year in December, following a 1.7% rise in November and matching market expectations. The inflation rate accelerated for the fifth consecutive month to the highest since June of 2014, boosted by gasoline and shelter costs.

It should be noted that the inflation rate in the US averaged 3.29% from 1914 until 2016, reaching an all time high of 23.7% in June 1920 and a record low of -15.8% in June 1921 -- some pretty crazy years prior to WWII.

So in 2016, year-on-year energy prices jumped 5.4%, following a 1.1% rise in November. Inflation accelerated for transportation services (2.8% from 2.5% in November) and was steady for shelter (3.6%) and medical care (3.9%). In addition, food prices declined at a slower 0.2% (-0.4% in November).

Annual core inflation, which excludes food and energy, rose to 2.2% from 2.1% in the previous two months and matching expectations. Prices are definitely beginning to surge, which unfortunately may inspire some action taken by the Federal Reserve to limit the growth from becoming too out of control.

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