This is the first time I’ve seen such high inflation in my life and I just can’t understand what happens when inflation comes back down. Restaurants, hair salons, mechanics, and everything has gone up. So when inflation comes back down will these businesses lower their prices down as well? I just don’t see it happening. Will prices come back down?
These days I see a lot of people associate, and often confuse, two separate issues, both of which contribute to rising prices. These days there are two main situations which are causing prices to rise: supply chains and inflation. Both of these problems raise prices, but how they operate and what will happen in the future as a result of them is different.
First, let’s look at supply concerns. Partly due to the covid-19 pandemic and partly due to war in parts of the world, some businesses are having trouble getting supplies from Point A to Point B. If you’re importing a car, computer parts, food, or buiding materials then chances are there is a limited supply and delays in the transportation of the goods. This causes a temporary shortage and prices go up.
The bad news is prices tend to spike quite a bit as demand outpaces the ability of businesses to deliver supplies and goods. The good news is that once the supply chain settles down and starts to return to normal, the spike in prices should drop. Either the companies providing the goods will lower their prices as costs come down, or competition will swoop in and offer the same goods at a lower price. This should cut prices back down to close to what they were before the supply chain woes began.
Inflation is another issue. Inflation happens when there is more money flowing through the economy and, as a result, the value of each dollar is reduced. For the past 20+ years we’ve had unusually low interest rates, which meant a lot of people and businesses were borrowing money, which increased the amount of dollars in the economy. This is causing the value of the dollar to drop, currently at a rate of about 6% to 8% per year. In other words, the $1.00 you earned a year ago is worth about $0.92 today. Since each dollar is worth a bit less, the cost of goods is going up. The bread you buy today for $2.00 will cost about $2.16 in a year, due to inflation.
Interest rates are rising at the moment, which should cut back on borrowing, which should cause inflation to level out.
Now, here is the thing about inflation: it can speed up or slow down, but it almost always continues to rise. Inflation will virtually always happen, eroding the value of money, it’s just a question of how fast. During most of the past 25 years inflation has been low (around 2%) but now it’s up around 8%. If the interest rate hikes work, inflation should settle back down around 2% or 3%, but it’ll still be there, slowly pushing up prices.
What this means is, if inflation is reduced back down to its original levels, it’ll still be there. Prices which rose due to inflation won’t go back down, they’ll just rise more slowly.
This can be confusing because, let’s say you wanted to buy milk. Last year it was $4.00. Due to inflation the price rose 8% to $4.32. Then due to supply issues the price jumped another $4.00. So now milk costs $8.32. If the supply issues are sorted out, milk may drop back down to $4.32 again, but it’ll still continue to slowly rise in price due to inflation. Meaning in a year or so it’ll likely be up to $4.50. The price isn’t going to drop back down to its original $4.00 because inflation, even when it’s low, is still almost always slowly pushing up prices.
The cost of things may go down quite a bit, thanks to supply chain issues being resolved, in the coming years. However, they’ll never go back to the level they were before inflation shot up.
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