Econified

The Bureau of Labor Statistics (BLS) released the November Consumer Price Index (CPI) report today. The full report can be found here. The BLS reports on CPI because it is the most common metric for inflation in the economy. The report shows that inflation has been slowing down, and it has fallen to 2.7% annual rate from the previous 3.0% rate that was reported in September. A 0.3% fall in inflation over a 2-month period is great. While this news is positive, there is some nuance in economic conditions that may have caused this decrease.

Inflation Goals

The Federal Reserve’s inflation goal is 2.0% in the long-term, so inflation is still well above that goal. Inflation has slowly been worsening over the past few months since hitting 2.3% in April of this year. This means there has been a 0.7% increase in inflation in 6 months, which is concerning. It is still encouraging to see that inflation has gone down since September. October data is unavailable because the BLS was shut down during the lapse in government appropriations for the entirety of the month of October.

Inflation rates under 2% are not necessarily advisable because it could lead to decreased consumer spending. The Federal Reserve utilizes interest rates to combat inflation. The most recent rate cut in early December could cause worsening inflation. The reason for this decision was to help with unemployment. Economists suggest that inflation typically only has short term effects because price inflation should also come with wage inflation. This way, in the long run, the purchasing power of wage earners stays the same. This is not necessarily the case because wages do not always keep up with inflation. Additionally, inflation can be particularly impactful in the short term because wages are relatively static and cannot be changed dynamically to reflect increased prices in the short term. Theoretically in the long term, increased prices should mean higher revenues which will mean higher wages.

Why Did Inflation Decrease?

More money in the economy will cause more inflation. There is a limited amount of goods and services that the economy produces, but there is not a fixed amount of money. Adding more money to the economy without increasing output will cause inflation. This is because the economy will have more money to compete for the limited resources, making prices rise.

The inflation rate going down in November could be for a lot of reasons. It was a surprise as most projections did not anticipate a decrease to this magnitude. President Trump’s tariff policies are inherently going to cause increased inflation, at least in the short run. Despite these tariff policies still be in place, inflation decreased. The most likely reason is that borrowing is down because interest rates are high. Also, President Trump has signaled that he will appoint someone to chair the Federal Reserve who will lower interest rates. High interest rates make it more expensive to borrow. Knowing rates will decrease soon, borrowers are likely to wait until they can access a more favorable rate.

The reason why high interest rates can slow down inflation is because debt adds money to the economy. When banks lend money, they are lending money that someone else has deposited. Let’s say that 100 people combined deposit $100K at the bank. Then, the bank loans $90K of that money to a business. The business now has $90K to spend, and the people who deposit money at the bank also have $100K in the bank. Because of the $90K in debt, there is now $190K in the economy from an initial $100K deposit. This is a very simple example, and the actual concept is called a “money multiplier”. This concept is a little bit more in-depth than this article covers, but it boils down to more debt equals more money in the economy. Again, more money (if higher than growth) will cause inflation.

Lower interest rates = more debt = more money = higher inflation.

Takeaway

The economy is poised with high levels of inflation this year. President Trump’s monetary policies such as large tax refunds and a stimulus check for military members adds more money to the economy. Tariff policies are also inherently inflationary. Once the Federal Reserve drops interest rates to more affordable levels, many more individuals and businesses will start to borrow money. All these factors will all add up to yield very high inflation numbers. To combat this, the Federal Reserve may have to raise interest rates to combat inflation. However, President Trump has been very vocal about lowering interest rates. It is unclear now if President Trump’s nominee for the Federal Reserve chair will go against the president’s wishes and raise interest rates, even if it is needed to stop rising inflation.

President Trump’s economic policies have been shown to increase domestic investment. Lower interest rates and increased domestic investment will yield growth for U.S. outputs. This will increase quality of life in the long term. Additionally, higher growth may also overshadow the rising inflation, so the inflation rate may not rise. Smart decisions by the Federal Reserve and dynamic monetary policies when it comes to stimulus checks and foreign tariffs will be key to overall success.

The November inflation figures are very positive. This news will not have much impact on the stock market, but U.S. consumers will benefit from lower inflation. The goal is to keep these inflation numbers on the right track as the Federal Reserve aims for 2%. The lower inflation this month might be caused by expectations of decreasing interest rates in the future. This will signal higher inflation numbers in the future, but it could be overshadowed by increased growth in the economy. Overall good news from the BLS on inflation numbers in November, and hopefully inflation will continue to fall to healthier levels.