What Inflation Really Is—and Why It Is Not Going Away

Inflation Is Not Simply Higher Prices. It Is a Persistent Change in the Relationship Between Money, Production, Credit, and Scarcity.

Menger Business Review September 10th 2026

Abstract

Inflation is among the most frequently discussed yet frequently misunderstood phenomena in economics. Public discussion commonly treats inflation as synonymous with rising consumer prices. This interpretation is incomplete. Higher prices are the observable manifestation of a deeper economic process involving money and credit, aggregate demand, productive capacity, resource scarcity, wages, expectations, fiscal policy, energy, and the institutional structure through which capital is allocated.

Understanding this distinction is particularly important in the contemporary United States. Inflation may decline substantially from its cyclical peak without returning permanently to the exceptionally subdued environment that characterized much of the period preceding 2020. The structural forces influencing prices have changed. Large fiscal requirements, persistent government borrowing, geopolitical fragmentation, energy constraints, industrial policy, changing labor dynamics, supply-chain restructuring, infrastructure investment, and extraordinary capital requirements associated with artificial intelligence and electrification increasingly compete for finite productive resources and financial capital.

The central thesis of this article is therefore not that inflation must continuously accelerate. Nor is it that every price must rise indefinitely. Rather, the argument is that the American economy may have entered a regime in which inflationary pressure is structurally more persistent, more volatile, and more difficult to suppress than markets became accustomed to during the previous several decades.

Understanding why requires first understanding what inflation actually is.

I. Inflation Is Not the Price of One Thing

The first principle of inflation analysis is simple:

A price increase is not necessarily inflation.

If a drought destroys part of the coffee harvest, coffee prices may increase.

If semiconductor production expands faster than demand, semiconductor prices may decline.

If a city experiences rapid population growth without sufficient housing construction, rents may increase.

These are changes in relative prices.

Markets constantly adjust relative prices because scarcity, preferences, technology, productivity, supply, and demand continually change. Inflation is broader. Inflation represents a sustained increase in the general price level—or, expressed from the opposite direction, a sustained decline in the purchasing power of money.

This distinction matters.

When one price increases relative to others, consumers and businesses can substitute, reorganize production, reduce consumption, or allocate resources differently.

When the general price level rises, the measuring unit itself is changing. A dollar purchases less.

The economic question therefore becomes considerably deeper than:

Why did prices rise?

The appropriate question is:

What changed in the relationship between nominal purchasing power and the economy's capacity to produce real goods and services?

That is the foundation of serious inflation analysis.

II. Inflation Is a System

Inflation should not be understood as a single-variable phenomenon.

It is better represented as a system:

Money + Credit + Fiscal Demand + Private Demand → Aggregate Nominal Purchasing Power

interacting with:

Labor + Energy + Commodities + Technology + Capital + Productive Capacity → Real Economic Supply

The relationship between these systems helps determine the general price environment. When nominal purchasing power expands faster than the economy's capacity to produce goods and services, prices tend to face upward pressure.

But the mechanism is rarely instantaneous or uniform.

Money moves through institutions.

Credit moves through banks and capital markets.

Government expenditures enter particular industries.

Investment creates demand for specific labor, commodities, machinery, land, energy, and intellectual capital.

Households allocate income according to changing preferences.

Businesses adjust inventories, wages, production, and prices.

The resulting inflation process therefore propagates through the economy rather than appearing everywhere simultaneously. This is why inflation should be analyzed as a dynamic economic process, not merely as an index.

III. CPI Measures Inflation. It Does Not Explain It.

The Consumer Price Index is valuable. So is the Personal Consumption Expenditures price index.

Producer prices matter.

Import prices matter.

Wages matter.

Commodity prices matter.

Inflation expectations matter.

But none of these statistics, individually, constitutes a theory of inflation.

CPI tells us how the prices of a representative basket of consumer goods and services have changed. It does not tell us why.

That distinction is critical.

Suppose CPI falls from 7 percent to 3 percent. Inflation has slowed. Prices have generally not returned to their previous level. A product costing $100 before a cumulative increase to $110 does not become $100 again merely because the inflation rate declines. The price may instead rise more slowly.

This is the distinction between inflation and disinflation.

It is also one of the primary reasons households can continue reporting substantial cost-of-living pressure even after headline inflation falls dramatically.

The rate of deterioration in purchasing power has slowed. The deterioration that already occurred has not automatically reversed.

IV. Inflation Is Cumulative

Consider a simplified sequence.

Assume an item initially costs $100.

After 8 percent inflation:

$100 → $108

After another 5 percent:

$108 → $113.40

After another 3 percent:

$113.40 → $116.80

Inflation has fallen from 8 percent to 3 percent.

But the price has increased nearly 17 percent from its starting point. This is why statements such as "inflation has fallen" can sound disconnected from household experience.

Both observations can be correct.

The rate of price increase has fallen.

The price level remains substantially higher.

This distinction should be central to economic communication.

V. The Monetary Foundation

Money remains fundamental to inflation analysis. Money is the common denominator through which goods, services, labor, assets, debts, and contracts are valued.

If nominal purchasing power expands significantly relative to available real output, the purchasing power of each monetary unit can decline. But modern money cannot be understood exclusively through physical currency.

The contemporary monetary system includes bank deposits, credit creation, government liabilities, central-bank reserves, financial markets, and expectations concerning future policy.

Consequently, the relevant mechanism is broader:

Money → Credit → Spending Capacity → Demand → Production Constraint → Price Adjustment

The quantity of money matters.

But so do velocity, credit conditions, asset prices, savings behavior, productive capacity, and the willingness of households and businesses to spend. This is why identical changes in the money supply can produce different economic consequences under different conditions. Money must be analyzed within the economic system through which it circulates.

VI. Credit Is the Hidden Inflation Variable

Credit deserves substantially more attention in inflation analysis.

Credit allows future income to become present purchasing power.

A household does not need the full purchase price of a house to bid for one.

A corporation does not need retained earnings equal to the cost of a new factory.

A government does not need current tax revenue equal to current expenditure.

Credit bridges the difference.

Consequently:

Credit expansion → Purchasing power expansion → Demand expansion

provided borrowers actually deploy the capital.

When credit expands faster than productive capacity, inflationary pressure can emerge even without an immediately obvious monetary explanation. Conversely, severe credit contraction can produce powerful disinflationary or deflationary forces.

This is why inflation cannot be separated from the credit cycle. Money is important.

But money and credit together determine much of the economy's effective purchasing capacity.

VII. Fiscal Policy Has Become an Inflation Variable

One of the most important structural changes in the contemporary economy is the increasing importance of fiscal policy.

Government spending is not economically neutral.

It creates demand.

When governments spend borrowed money, that spending enters the economy through contractors, households, defense companies, healthcare systems, infrastructure projects, manufacturers, employees, suppliers, and financial institutions.

This can support economic activity.

It can also create inflationary pressure when demand for resources exceeds the economy's ability to supply them.

The sequence can be expressed as:

Deficit Spending → Treasury Borrowing → Government Expenditure → Private Income/Demand → Resource Competition → Potential Price Pressure

The effect depends on economic conditions.

Government spending during severe unemployment and unused industrial capacity does not necessarily produce the same inflationary effect as equivalent spending when labor markets, factories, energy infrastructure, or supply chains are already constrained. This is the central point.

Inflation is determined not merely by spending, but by spending relative to available productive capacity.

VIII. Why Government Debt Matters

Persistent fiscal deficits introduce another mechanism. The federal government must finance the difference between revenue and expenditure. That generally means additional Treasury issuance.

As financing requirements increase, government borrowing competes within global capital markets for savings.

This can affect long-term interest rates.

The transmission mechanism becomes:

Fiscal Deficit → Treasury Issuance → Capital Demand → Treasury Yields → Corporate Borrowing Costs → Mortgage Rates → Discount Rates → Capital Allocation

This does not mean deficits mechanically cause inflation in every period.

It means fiscal conditions increasingly influence the price of capital.

And the price of capital ultimately influences the supply side of the economy.

Higher financing costs can discourage investments that would otherwise expand productive capacity.

Thus, fiscal policy can influence inflation from both directions:

by supporting demand and by affecting the financing conditions under which future supply is created.

IX. Energy Is Embedded in Almost Everything

Energy is not merely another category in the Consumer Price Index.

It is an input into nearly the entire production structure.

Energy affects:

transportation,

manufacturing,

agriculture,

mining,

construction,

chemicals,

logistics,

data centers,

utilities,

aviation,

shipping,

and household consumption.

When energy becomes more expensive, the effects propagate.

Energy → Transportation → Production → Distribution → Retail → Consumer

This is why geopolitical instability in energy-producing regions can become an inflation problem thousands of miles away.

An oil shock is not simply a higher gasoline price.

It can become a cost shock transmitted throughout the structure of production.

And unlike demand-driven inflation, supply-driven inflation creates an especially difficult problem for central banks.

Higher interest rates cannot produce oil.

They cannot build pipelines overnight.

They cannot manufacture transformers.

They cannot open shipping lanes.

Monetary policy can reduce demand.

It cannot immediately create supply.

X. The World Is Becoming Less Economically Frictionless

The inflation environment of the 1990s and 2000s benefited from powerful disinflationary forces.

Globalization expanded.

China integrated deeply into global manufacturing.

Supply chains became increasingly optimized.

Labor pools expanded.

Trade barriers declined across important regions.

Technology reduced transaction costs.

Energy supplies expanded.

Companies moved production toward lower-cost jurisdictions.

Capital moved globally with increasing efficiency.

These developments placed persistent downward pressure on the prices of many manufactured goods. The contemporary environment is different.

Supply chains are increasingly being reorganized around resilience and national security rather than cost alone. Production is being reshored or friend-shored.

Trade restrictions have increased. Strategic industries are being subsidized.

Defense expenditures are increasing.

Governments are seeking domestic semiconductor capacity.

Energy security has returned to national strategy.

These developments may produce important strategic benefits.

But resilience is often more expensive than maximum efficiency.

Redundancy has a cost. And that cost can ultimately appear in prices.

XI. Tariffs Do Not Create Resources

Tariffs illustrate this principle.

` A tariff changes relative prices by increasing the domestic cost of imported goods.

The longer-term objective may be to encourage domestic production.

But domestic production requires resources:

labor,

factories,

land,

energy,

machinery,

capital,

raw materials,

transportation,

and time.

If those resources are already scarce, shifting production domestically can initially increase competition for them.

Consequently, industrial policy can simultaneously improve strategic resilience while increasing short- or medium-term cost pressures. This is not an argument against industrial policy. It is an economic constraint that policymakers and businesses must recognize. There is rarely a free transition between economic regimes.

XII. Labor Has Changed

Labor markets represent another structural source of inflation uncertainty.

Wages are simultaneously:

income to households and costs to businesses.

If wages rise because productivity rises proportionately, businesses can often absorb those increases without significant inflationary consequences.

If wages increase persistently faster than productivity, unit labor costs rise.

Companies must then choose among:

lower margins,

higher productivity,

automation,

reduced employment,

or higher prices.

This gives us an important relationship:

Wage Growth − Productivity Growth ≈ Unit Labor Cost Pressure

It is not an exact inflation equation. But it is a powerful analytical relationship.

The crucial question is therefore not whether wages are rising. They should rise in a productive economy. The question is whether productivity can rise sufficiently to support them.

XIII. Artificial Intelligence Is Both Inflationary and Disinflationary

Artificial intelligence introduces an unusual duality. Over the long term, AI could be profoundly disinflationary. If artificial intelligence allows businesses to produce substantially more output with the same labor and capital, productivity rises.

Greater productivity expands real economic supply. That is fundamentally favorable for price stability. But building the AI economy requires enormous physical investment.

Data centers require land.

Semiconductors require fabrication capacity.

Computing requires electricity.

Electricity requires generation.

Generation requires transmission.

Transmission requires transformers, copper, steel, equipment, engineering, permitting, and capital.

The near-term mechanism can therefore be:

AI Investment → Capital Expenditure → Energy Demand → Commodity Demand → Construction Demand → Skilled Labor Demand → Resource Competition

before eventually becoming:

AI Adoption → Productivity Growth → Higher Output → Lower Unit Costs

AI may therefore create inflationary investment pressure before producing disinflationary productivity benefits.

The timing difference matters enormously.

XIV. Inflation Is Also About Expectations

Inflation becomes more difficult to control when economic behavior begins adapting to it.

Workers expect higher wages.

Businesses expect higher supplier costs.

Landlords anticipate higher expenses.

Lenders demand higher yields.

Investors require greater inflation compensation.

Companies increase prices preemptively.

Long-term contracts incorporate escalation clauses.

Once expectations adjust, inflation can acquire persistence.

This creates a feedback mechanism:

Observed Inflation → Expected Inflation → Wage/Price Decisions → Future Inflation

This is why central-bank credibility matters.

The Federal Reserve's inflation objective is not merely a numerical preference.

It is an attempt to anchor expectations around a stable long-term monetary environment. If economic actors cease believing that inflation will return toward the objective, restoring price stability becomes substantially more expensive.

XV. Why Interest Rates May Remain Higher

Persistent inflation changes the equilibrium of capital markets. Investors lending money for ten, twenty, or thirty years must consider the future purchasing power of the dollars they will receive.

At a conceptual level:

Nominal Yield ≈ Real Yield + Expected Inflation + Risk/Term Compensation

If expected inflation rises, nominal yields generally require additional compensation. If uncertainty about future inflation rises, investors may demand an additional premium. This helps explain why long-term interest rates can remain elevated even when markets expect eventual Federal Reserve easing.

The bond market is pricing decades.

The Federal Reserve controls an overnight policy rate.

Those are not the same thing.

XVI. Why Inflation Is Not Going Away

The statement that inflation is "not going away" requires precision.

It does not mean inflation must remain at today's rate.

It does not mean another 1970s-style inflationary episode is inevitable.

It does not mean monetary policy is powerless.

It means the structural environment appears more inflation-prone than the one that prevailed during much of the pre-2020 era.

Several forces support this conclusion:

Persistent fiscal deficits create continued demand and substantial government financing requirements. Geopolitical fragmentation makes global production less efficient. Supply-chain resilience requires redundancy that often costs more.

Energy constraints can create economy-wide cost pressures.

Industrial policy and reshoring require enormous physical investment.

Defense spending competes for industrial capacity.

Artificial intelligence infrastructure competes for electricity, semiconductors, construction, metals, land, and capital.

Labor-market changes can increase wage pressure where productivity does not compensate.

Housing shortages create persistent shelter-cost pressure in many regions.

Higher inflation expectations, if allowed to develop, can reinforce the process.

None of these forces independently guarantees persistent inflation. Together, however, they describe an economy in which the path back toward stable 2 percent inflation may be substantially more difficult than simply waiting for pandemic-era disruptions to disappear.

XVII. The Difference Between Persistent Inflation and Accelerating Inflation

This distinction is essential.

Suppose inflation moves:

7% → 5% → 3.5% → 3% → 2.8%

Inflation is clearly declining. Yet if the economy struggles to move from approximately 3 percent toward 2 percent, inflation remains persistent.

The final percentage point can be economically more difficult than the first several.

Early disinflation can occur as supply chains normalize, commodity shocks reverse, inventories adjust, and extraordinary demand moderates.

The remaining inflation may be embedded in:

services,

housing,

wages,

insurance,

healthcare,

energy infrastructure,

fiscal demand,

and expectations.

These components can respond more slowly to monetary restraint.

This is the essence of the contemporary inflation problem.

The issue may no longer be reducing inflation from extremely high levels.

The issue may be achieving the last mile of price stability.

XVIII. What This Means for Business

Persistent inflation changes corporate strategy.

Executives cannot simply assume the cost structure of the 2010s will return.

Businesses should increasingly focus on:

pricing power,

gross-margin management,

working-capital efficiency,

debt maturity schedules,

interest-rate exposure,

supplier diversification,

productivity investment,

capital allocation,

cash-flow forecasting,

and scenario analysis.

Inflation also increases the importance of distinguishing nominal growth from real growth. A company whose revenue increases 5 percent while its input costs increase 7 percent has not necessarily become economically stronger.

Nominal revenue can conceal deterioration in real economic performance.

Management must therefore ask:

How much of our growth represents additional volume, productivity, and value creation—and how much merely represents higher prices?

That question becomes indispensable in an inflationary regime.

XIX. What This Means for Investors

Investors face a similar problem. Inflation affects both the numerator and denominator of asset valuation. Corporate revenues may rise nominally. But so can expenses.

Meanwhile, higher inflation can produce higher discount rates.

Thus:

Higher Nominal Earnings ≠ Higher Real Value

The decisive variables become:

real cash-flow growth,

pricing power,

capital intensity,

balance-sheet quality,

debt structure,

return on invested capital,

and the discount rate applied to future cash flows.

Businesses capable of increasing productivity and maintaining pricing power may navigate inflation successfully.

Highly leveraged businesses dependent upon cheap refinancing may not.

The inflation regime therefore changes not only asset prices.

It changes which business models possess structural advantages.

XX. Inflation and the Economic-First Framework

Inflation should never be analyzed independently of the broader economy.

The proper sequence is:

Economic Activity → Labor → Wages → Demand → Production → Capacity → Energy → Credit → Fiscal Policy → Inflation → Monetary Policy → Yield Curve → Cost of Capital → Corporate Behavior → Asset Prices

The relationships operate in both directions and include feedback loops.

But the principle remains.

Inflation is not an isolated statistic.

It is embedded within the economic system.

That is why an economic-first approach begins before CPI and continues long after the CPI release. The objective is not simply to know the inflation number. The objective is to understand the economic mechanism producing it.

XXI. Conclusion: Inflation Is the Price of Economic Imbalance

Inflation is ultimately a problem of relationships.

The relationship between money and goods.

Between credit and productive capacity.

Between wages and productivity.

Between government demand and available resources.

Between energy supply and energy consumption.

Between investment and savings.

Between expectations and monetary credibility.

Between nominal purchasing power and real economic output.

When those relationships become imbalanced, prices adjust.

The contemporary inflation problem therefore cannot be reduced to the pandemic, the Federal Reserve, government spending, corporate pricing, energy, wages, tariffs, or supply chains individually.

Each represents part of a larger economic system.

And that system has changed.

The United States is rebuilding industrial capacity.

Supply chains are being reorganized.

Defense requirements are increasing.

Artificial intelligence is generating an enormous investment cycle.

Electricity demand is growing.

Government financing requirements remain substantial.

Geopolitical risk has returned to economic decision-making.

Capital is more expensive.

These forces do not guarantee runaway inflation.

But they make the return to the exceptionally low and stable inflation regime of the previous era considerably less certain. The appropriate conclusion is therefore not that inflation can never fall. It can.

The more important conclusion is this:

Inflation may fall without disappearing as an economic constraint.

The era in which businesses, households, investors, and policymakers could routinely assume inexpensive capital, abundant global supply, cheap energy, frictionless trade, and persistently subdued inflation may be behind us.

The next economic regime may demand something different:

greater productivity,

greater capital discipline,

greater supply resilience,

greater monetary credibility,

and a far more sophisticated understanding of inflation itself.

Because inflation is not simply the number printed in the monthly CPI report.

Inflation is the monetary expression of pressures building throughout the economic system.

Understanding those pressures is how we understand what comes next.

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