This is just one of the stories from our “I’ve Always Wondered” series, where we tackle all of your questions about the world of business, no matter how big or small. Ever wondered if recycling is worth it? Or how store brands stack up against name brands? Check out more from the series here.
Listener Sean Thursby asks:
How does inflation actually work? Prices continually increase over time, but why? And why do they never decrease?
When the Labor Department releases the monthly consumer price index, the question is by how much prices increased, not whether they will. In May, prices rose by 2.4% year-over-year, according to the latest index.
One of the main reasons prices, on average, have increased over time is that the Federal Reserve has a 2% yearly inflation target. The central bank tries to gradually increase the money supply to hit its target, said William Hauk, an associate professor of economics at the University of South Carolina.
The Fed can increase the amount of money circulating in the economy by purchasing government and mortgage-backed securities. If the Fed buys mortgage-backed securities from banks, for example, that means they have greater cash reserves, which makes it easier for them to lend more money to their customers.
When consumers have more cash to spend and the amount of goods and services they want stays the same, then those goods and services become more expensive, Hauk said.
It all goes back to supply and demand. “More money chasing fewer goods causes prices to increase,” Hauk said.
Sometimes inflation becomes challenging to tame. Consumer prices rose substantially during the pandemic and peaked at 9.1% in June 2022. Two-thirds of Americans say they are very concerned about the cost of consumer goods and housing, according to an April survey from the Pew Research Center.
But while consumers want prices to go down, deflation is a sign of a struggling economy.
“High inflation causes lots of problems as we’ve seen in recent years, but deflation, falling prices, can cause really big problems as well,” Hauk said.
If you look back at the Great Depression, prices fell about 27% on average between 1929 and 1933 and the unemployment rate reached more than 25% at one point. And in July 2009, during the Great Recession, consumer prices fell by about 2.1% as the unemployment rate hit 9.5%.
“If prices are falling, sure, it’s making goods and services cheaper, but it also means that people are spending less and less money,” Hauk said.
Less spending causes the economy to slow down since businesses will have trouble selling products, leading to higher unemployment, Hauk said.
“One person’s spending is another person’s income,” Hauk noted.
Consistent price increases are a sign that a country’s economy is growing, said Fabio Gómez-Rodríguez, an assistant professor of economics at Lehigh University.
But not all products increase in price indefinitely. Electronic goods like computers and TVs belong to a category known as disinflationary goods because their prices have decreased over time.
When it comes to PCs, semiconductor technology has reduced the cost of computing power, allowing them to remain somewhat affordable. The PC market is also very competitive, which means companies will have a harder time selling their goods if they raise prices, said Tom Mainelli, group vice president of device and consumer research at IDC, in a 2022 Marketplace interview.
Computer prices dropped 3.5% year-over-year, according to May’s Consumer Price Index. Other categories that dropped in price include fresh and frozen vegetables, gas and some clothing items.
For consumers, these are a small reprieve. While President Donald Trump’s tariffs aren’t reflected in the data yet, tariff prices are expected to come later this year.
