What causes inflation? There are two main things that impact inflation and that is the money supply and velocity. Money supply is how much money is in the system. With all the government spending that has been going on to prop up the failing economy there is plenty of money out there. The money supply has more than doubled. The Fed’s balance sheet went from 928 Billion to 2.1 trillion dollars in a very short amount of time. So, why are we not seeing inflation yet? The answer to that is the second cause of inflation and that is the velocity, or how fast is money exchanging hands. There are basically three reasons that we are not seeing inflation yet.
1. Banks are not lending
If you have tried to get a loan recently, you have probably seen that credit is harder to get. Many banks almost died and are now on life support, also known as, the tax payer’s money. After experiencing this near death experience many banks are a bit nervous about extending credit to a consumer that is struggling to get by.
2. The unemployment rate.
Unemployment is at levels we have not seen since the 80s it and if you include people that have stopped looking for jobs and part time workers, that number is actually higher. Unemployment is currently at about 10 percent.
3. Consumers are not spending money
Many people have seen their home and stock values drop like a rock. People are still a bit nervous about spending money.
These three things are holding inflation down. What will happen once the economy starts to recover and these three factors change? Once those three things start to happen? We will see inflation. The Federal Reserve could cut back on the supply of money in the economy to slow down inflation but that would also slow down the recovery.
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