Here’s a guide to understanding what’s going on with inflation and how to think about price increases when you go through this complex moment in the US and world economy.
What causes inflation
It can be helpful to think about the causes of inflation today that fall into three related buckets.
– High demand. Consumers spend a lot. Early in the pandemic, households accumulated savings as they were trapped at home, and government support, which continued into 2021, helped them invest even more money. Now people are taking jobs and earning wage increases. All of these factors have filled household bank accounts, allowing families to spend on everything from backyard barbecues and beach vacations to cars and kitchen tables.
– Too few products. As families have been saving for pandemics and trying to buy pickup trucks and computer monitors, they have run into problems: There have been too few products to carry around. Factory closures related to the pandemic, global transport load and reduced production have led to a shortage of spare parts and products. Because demand has outstripped product supply, companies have been able to charge more without losing customers.
Right now, the latest closures in China are increasing tensions in the supply chain. At the same time, the war in Ukraine is cutting back on the world’s supply of food and fuel, pushing inflation overall and increasing the cost of other goods and services. Gasoline prices average about $ 5 a liter nationwide, up from just over $ 3 a year ago.
– Pressure in the service sector. Recently, people have been shifting their spending from things and back to the experiences as they adapt to life with the coronary heart disease virus – and inflation has been springing up in the service sector. Rents are rising rapidly as Americans compete for a limited supply of apartments, restaurant bills rise as food and labor costs rise and tickets and hotel rooms cost more because people are willing to travel and because fuel and labor are more expensive.
You may be wondering: What is the role of corporate greed in all of this? It is true that companies have been raking in unusually large profits as they raise prices by more than necessary to cover rising costs. But they can do it in part because demand is so high – consumers are spending right through price increases.
How is inflation measured?
Economists and politicians are closely monitoring the two main inflation indicators of the United States: the consumer price index, which was published on Friday, and the main consumer price index.
The consumer price index captures how much consumers pay for the items they buy, and it comes out earlier, which means that the nation has the first clear insight into what inflation did the month before. Data from the index are also used to compile the PCE numbers.
The PCE index, released on June 30, measures how much things actually cost. For example, it counts the cost of health care, even when the government and insurance companies help pay for it. It tends to be less volatile and is the index that the Central Bank looks at when it tries to reach 2% inflation on average over time. As of April, the PCE index rose by 6.3% year-on-year – more than three times the Central Bank’s target.
Fed officials are closely monitoring the change in inflation between months to get a feel for its momentum.
Policymakers are also given special attention to the so-called core inflation measurement, which reduces food and fuel prices. Although food and petrol are a large part of households’ budgets, they also jump in price in response to changes in global supply. As a result, they do not give a clearer reading of the underlying inflationary pressures in the economy – those in which the Fed believes it can do something.
What can slow down rapid price increases?
How long prices will continue to rise rapidly is everyone’s guess: Inflation has repeatedly confused experts since the pandemic took over in 2020. But given the driving forces behind today’s high prices, some results seem likely.
At first glance, rapid inflation seems unlikely to go away on its own. Wages are rising much faster than usual. This means that unless companies suddenly become more efficient, they will probably try to keep raising prices to cover labor costs.
As a result, the central bank raises interest rates to slow down demand and reduce wage and price growth. The Central Bank’s policy response means that the economy is almost certain to slow down. Higher borrowing costs are already cooling the housing market.
The question – and a great deal of uncertainty – is just how much action the Fed needs to curb inflation. If America is lucky and the shortage of the supply chain decreases, the central bank could be able to drop the economy gently, slowing down the labor market sufficiently to curb wage growth without causing a contraction.
In this optimistic scenario, often called a soft landing, companies will be forced to lower their prices and lower their huge profits when supply and demand come into balance and they compete for customers again.
But it is also possible that supply problems will persist, leaving the central bank with a more difficult task: to raise interest rates sharply to slow down demand sufficiently to cope with price increases.
“The road to a soft landing is very narrow – narrow to the point where we expect a contraction as a baseline,” said Matthew Luzzetti, chief economist at the United States at Deutsche Bank. This is in part because consumer spending shows little sign of clicking so far.
Homes still have about $ 2.3 trillion in excess savings to help them withstand higher interest rates and prices, Luzzetti’s team has estimated.
“There continues to be deep pockets of closed demand,” said Anthony Capuano, CEO of Marriott International, at an event on Tuesday. “Unlike previous economic fluctuations and economic downturns, you have this increased dimension, which was that people were locked up for 12 to 24 months.
(This article originally appeared in The New York Times)
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