As economies around the world begin to recover, business owners and consumers alike are starting to breathe a sigh of relief. But as most of us have likely either heard about or even experienced already, there are foreboding signs the economic recovery may not exactly be as strong as we need it to be.

That’s because we’ve found ourselves in the midst of a recovery where there are major scarcities of commodities and basic goods, rising wages, worker shortages, higher shipping costs, growing government debt, and perhaps most forebodingly of all, drastically increasing inflation rates.

Inflation rose by 5.4% in the U.S. this last June, which represents the largest increase in over 13 years. This has made many everyday consumers and policymakers worried that the economic blow from the lockdowns during the pandemic are really here to stay for the long term, and that the return-to-life we’re currently witnessing in the economy will not continue to last into the next year.

Or could the opposite be true? Let's explore inflation, the primary factors behind its rise, and what the rapid spike we’re seeing now represents to the economic recovery as a whole.

What Is Inflation and And Is It Bad?

Inflation is often considered a "dirty" word in the arena of politics and economics. Most people, when they hear the term, associate inflation with decreased purchasing power for each individual dollar. Therefore, when high inflation rates are discussed in the news, there’s a sinking feeling many consumers have that the value of their money is decreasing.

However you choose to feel about it, the truth is that inflation is simply a measurement of supply and demand in the economy. It is true that higher inflation rates translate to less purchasing power in each individual unit of currency. As more dollars are produced, for instance, the relative value of other dollars starts to decrease.

This is measured in the consumer price index, or the average prices of different services and goods that are typically purchased by households. Besides helping to measure the cost of living, inflation is also used to help businesses set prices for their goods and give pay raises, and to help governments adjust benefits as appropriate.

Furthermore, it’s commonly argued that inflation to some degree is also needed to help drive consumption in an economy and sustain economic growth. That’s why moderate levels of inflation are considered normal. An annual inflation rate in the consumer price index is targeted each year by the Federal Reserve, which is usually in the vicinity of 2%.

The logic behind this is that a price level that steadily increases helps ensure most businesses of consumer goods are kept profitable. Otherwise, most consumers would naturally wait for prices to decrease before spending more of their money, which translates to decreased profits for business.

So, what’s causing the dramatic increase in inflation that we’ve seen this year?

What’s Causing Inflation To Rise Now?

As the economy grows, general demand from consumers increases. That’s why it’s perfectly normal to see inflation rise as the economy begins to claw its way back from the lockdown era.

It’s just the fact that we’ve seen an abnormally high inflation rate (and one that drastically exceeded the Fed’s prediction of 3.4% earlier this year) that is making many individuals, business owners, economists, and politicians so concerned. And while the Fed has indicated that the current soaring inflation is most likely merely ‘transitory’ and that we should expect to see a 3% inflation rate heading into next year, there’s no denying the general apprehension many are feeling in the general public.

Further compounding fears is how Western countries in North America and Europe are experiencing severe shortages of basic goods such — computer chips, lumber, and gasoline to name a few — coupled with slower shipping times and higher costs.

There’s also a big debate about whether inflation or the shortage of workers are to blame for the dramatic increase in wages we’re now witnessing as well. As the workers who benefit from the higher wages go out and purchase more items, inflation continues to increase to the detriment of those who aren’t enjoying a wage increase.

There are three big reasons why inflation is occurring to the extent it is now. The first and biggest reason is because of the increased money supply. There’s simply more money injected into the economy now than there was a year ago, most of which has come from government stimulus packages. Case in point, the money supply had increased by 30% in April 2021 when compared to April 2020.

Secondly, there has also been a massive reduction in the supply of basic goods. Due to the lockdowns from last year, much of the economy was shut down, which alone made it infeasible to maintain normal levels of production.

And then when the workforce started to return, there was the issue of fewer people returning to work - many of them were still enjoying unemployment benefits and other forms of financial aid from the government. This has resulted in many companies turning to outside sources (such as China) for supplies.

Despite the economic growth we’ve been witnessing these last few months, people still remain anxious largely thanks to the above factors. That’s why many people have been putting more of their money into investment portfolios and the stock market. It is a good rule of thumb to invest 20% of your income into a diversified portfolio, but then there’s the ever-looming question about what will happen to the stock market as well.

Is The Inflation We’re Seeing A Healthy Byproduct Of Economic Growth?

As indicated previously, a moderate level of inflation can be a good thing for the economy overall. Remember, if the average consumer has reason to believe that prices will go up in the near future, he or she is less likely to delay making a purchase.

And many investors and economists are clinging to the idea that the high inflation levels we are seeing now is purely temporary and that an inflation rate trending above the Fed’s target is necessary considering the highly unique circumstances of the last two years.

Even though inflation has risen at a higher pace than expected, this was actually coupled with a faster than expected recovery in the U.S. economy as well. Along with that, the unemployment rate has also dropped substantially from last year. It has to be asked: is a higher than expected inflation rate too steep of a price to pay for more people employed and life returning (mostly) to normal?

And if inflation does fade into the 3% range as many economists and politicians fully expect it to, the short burst we’ve seen this year could offer a number of advantages to the economy. Central banks for the last ten years have largely struggled to generate consistent growth in the consumer price index, and this year will have shown how it’s possible for economies to generate inflation. This is something that hasn’t happened in years.

And keep in mind, the U.S. has been through worse. In the 1970s, for instance, inflation skyrocketed into the double digits and while it wasn’t pretty the economy recovered.

None of this, of course, is to say that people shouldn’t be investing into financial safeguards. It is very wise, for instance, to have a diversified investment portfolio, building up a durable emergency fund, and generating extra income on the side via freelancing opportunities if you have the time. Investing in a comprehensive life insurance policy to help cover financial damages in the event of a death in the family’s primary income provider would also be a wise maneuver if you truly want to prepare for the worst.

And there is also no question that substantial economic challenges remain. The aforementioned issues of a shortage in the supply of basic goods, worker shortages, and increasing government debt are in need of solutions. Most likely, these solutions will come as the result of overreaching economic changes in a post-pandemic world.

What's The Bottom Line?

We’re already starting to see signs of rebounding optimism. In August, for example, inflation actually fell below expectations, which should help consumers feel more optimistic in the future. Ultimately, it’s perhaps just a little too soon to tell whether the high inflation rates of this year are reason to be concerned...or a sign to be hopeful.