The Rise in the Cost of Living

By Abigail McCullough

Introduction

Earlier this month, I was researching the cost of living in different cities within the United States. Upon my findings, I noticed that the price of houses and apartments has drastically increased within the last 10–20 years. It made me wonder what caused this substantial increase and if this growth will continue in the future. At what point will the increase in the cost of living be unattainable and unsustainable for society? Will there be massive amounts of growth in other sectors and necessities as well, such as groceries, clothes, and transportation? These questions were the driving force of my research, as I discovered that there is a direct relationship between the increasing cost of living, also known as inflation, and our country’s’ increasing national debt. 

Inflation

Inflation comes in two different forms: an increase in the money supply or an increase in the cost of a good or service from a change in supply and demand. These two different types of inflation can have very different outcomes for society and the way that it can function.

Increasing the Money Supply

When the money supply grows faster than the economic output of a country under normal economic circumstances, this can cause a massive rise in the average price of a good or service, also known as inflation. The Federal Reserve System, also known as The Fed, is the central bank of the United States. Therefore, it has ultimate control over the production and distribution of the money supply. The Fed is also responsible for “evaluating current market conditions and deciding whether to make changes to the money supply” (Gorton). After such evaluation, the Fed makes changes to the money by increasing or decreasing the discount rate, which is the cost for commercial banks to borrow money for short-term loans. If the Fed increases the money supply faster than the economy can manage, inflation will occur. Since there is a higher amount of money circulating within the economy than there are goods or services, the cost of each good or service will increase (Gorton).

In Gorton’s article on inflation, he utilizes an example of bananas and the amount of money circulating in the economy. The example states that if you have 100 bananas and an economy with $100, then the average price per banana would be $1. However, if the government increased the money supply by 10%, bringing the amount of money in circulation to $110, but the economy was only able to increase the supply of bananas by 5%, bringing it to 105 bananas, then the cost per banana would increase to $1.05. This inability to match the increase in supply with the increase in the money supply depicts inflation within the economy. 

If Gorton’s example was expressed with cars or houses instead of bananas, it would show that the price to buy goods may be unattainable for certain members of society. The increase in the money supply in today’s world can be shown using M2 graphs. M2 is a measure of the United States money supply, including money in circulation and savings deposits. The graph below demonstrates the drastic increase in the United States’ money supply from before 1985 up until today.

The M2 graph depicts a gradual increase in the money supply between 1985 and 2019, leading to the intense spike in 2020, generating the largest money supply increase in American history between 2020 and 2021 at 27%. The reason for this spike was the COVID-19 pandemic, as the Fed had to lower interest rates and increase the cost allocated for buying bonds to reduce economic damage from the pandemic. Since 2020, the money supply has not returned to its state before the pandemic, as the cost of living remains at an all time high. 

Changes in Supply and Demand

           The second form of inflation comes from the increase in price from a change in supply or demand. Unlike increasing the money supply, a change in supply and demand is based upon the consumers and producers, not the government. 

The first way to cause inflation between supply and demand is by increasing demand. An Hermès Birkin is one of the most sought after and admired handbags in the world. These handbags are seen as investment pieces because their value will increase with time because of how desired they are by consumers and how rare each color or pattern may be. 

If Hermès makes 20,000 Birkin bags per year, that supply number is fixed, therefore the demand curve must be the thing that changes. Since the supply is fixed, the demand curve shifts from D1 to D2, demonstrating an increase in demand from consumers, as the quantity demanded moves from Q1 to Q2, which will lead to an increase in price from P1 to P2. The increase in demand from consumers for a limited supply of Hermès Birkins indicates that the price per bag will experience the effects of inflation.

The second way that supply and demand can cause inflation is by decreasing the supply of a good or service. After the first strike of the COVID-19 pandemic, there were several products within the United States that consumers’ demands remained the same for and possibly even increased. The main product that caused chaos within grocery stores or convenience stores was paper products, such as toilet paper or paper towels, as these two items are seen as household necessities, especially when society was in a lockdown.

Manufacturers were unable to produce enough paper products to meet the demands of society, therefore the supply of toilet paper and paper towels decreased from S to S1, which also decreased the quantity supplied from Qe to Qe1. However, since the demand for paper products remained the same, the price for paper products was sacrificed, as the price increased from Pe to Pe1. As a result of the demand for toilet paper and paper towels during the pandemic, the price for paper products felt the effects of inflation, as prices increased and supply decreased due to a lack of resources and workers.

The Cost of Living and National Debt

Since the COVID-19 pandemic, our government has increased the national debt significantly as a way to keep our economy afloat. Before 2020, the government averaged about a $1 trillion increase in national debt per year. However, between the years of 2019 and 2020, the government increased the national debt by about $6 trillion, bringing it to $28 trillion in 2020 compared to $22 trillion in 2019. 

This massive increase in national debt has drastic effects on society, such as decreased economic growth and increased inflation rates. As discussed before, economic growth or decline and inflation go hand-in-hand, as it increases or decreases the cost of living for citizens. If the government continues to increase the national debt, then the economy will suffer and inflation rates will continue to grow, making it harder and harder for citizens to afford the basic needs for life. 

Works Cited

Oner, Ceyda. “Inflation: Prices on the Rise.” International Monetary Fund, International Monetary Fund, 2024, www.imf.org/en/Publications/fandd/issues/Series/Back-to-Basics/Inflation.

Gorton, David. “How Does Money Supply Affect Inflation?” Investopedia, 10 Oct. 2022, www.investopedia.com/ask/answers/042015/how-does-money-supply-affect-inflation.asp.