Inflation is one of the most difficult problems facing economists and government policymakers, and it is a factor increasing the risk of a US recession. The reasons are numerous, and tools typically deployed to mitigate price pressures can, in some scenarios, push the economy into recession.
Here’s what to know:
What is inflation?
Inflation refers to a widespread increase in prices or a fall in the value of money. This usually results in too much demand chasing too few goods or limited services, causing prices to rise. Increased prices do not necessarily harm the entire economy, and only those consumers who are making purchases experience the increase.
For example, vehicle shortages due to a lack of components such as semiconductors have led to a rapid increase in the prices of new and used autos. Unless you want to buy a vehicle, the increase in auto prices does not affect you.
High prices in a sector also do not necessarily lead to general inflation in the economy. But the increase in prices in many categories will weaken the spending power of consumers.
What is the cause of inflation?
There are many reasons for the current fight against inflation, many of which are linked to the pandemic. For one, consumers have been flush with savings from depressed services spending as a result of government stimulus programs and restrictions on businesses, prompting them to open the spigot for scarce-supplied goods.
Supply-chain disruptions to the global economy remain as well, with Russia’s invasion of Ukraine and the recent rise of Covid-19 cases in China adding additional pressure. Energy prices, including gasoline, have soared. Truck drivers, port slots and warehouse spaces are all in short supply, causing costly delays and rising shipping rates of goods.
There are fewer workers in the labor market, which encourages those working to increase demand. And the Federal Reserve’s lower interest rates have made borrowing cheaper, making larger purchases more attractive. These factors and many other factors are driving up the cost.
The added cost at every step from production to sales leads to an increase in prices for consumers, something companies seize on the rare opportunity to raise prices.
How is inflation measured?
There are different ways of measuring inflation even among government agencies. The shorthand version comes from the Labor Department’s consumer-price index, or CPI, which is calculated using a survey of households and includes spending only on goods and services. This does not include expenses that are not directly paid for, such as medical care paid for by a person’s health insurance. Its limited spending could make the CPI more volatile.
The personal-consumption-expenses price index, or PCE, takes into account a wide range of expenses — and feedback from businesses — to provide a more detailed picture of price changes. This inflation reading is the Federal Reserve’s preferred measurement. The Commerce Department releases its PCE estimates monthly as part of its income and expense reports.
How fast are the prices rising?
According to the Labor Department’s February report, the CPI is up 8.5% from a year ago. With food and energy removed from the picture—prices in those categories can be volatile—the CPI is up from a slightly lower rate of 6.5%. However, readings show that price increases are broad and well above policymakers’ targets for annual inflation, which averages around 2%. The Ukraine crisis has boosted oil prices, with US gasoline costs hitting record lows in early March, adding to already high inflation.
This pace is the fastest 12-month gain for core inflation in four decades, meaning nearly half the country has never seen the same stretch of price gains.
Which goods or services are causing the prices to rise?
Prices are rising throughout the economy, but not evenly. Prices of used cars rose 35.3% in March compared to a year ago. Food prices rose by 8.8%, the fastest increase since 1981. Restaurant prices have increased the most since the early 1980s. Grocery prices rose 10%, as meat and egg prices continued to climb double-digit rates year-over-year.
Wages are rising too, aren’t they? But are they growing enough to sustain people’s purchasing power given the pace of inflation?
In this tight labor market, workers are being raised. But in real-dollar terms, their money isn’t going as much as it used to be. Annual wage growth is at its fastest pace in two decades, but inflation is outpacing most workers’ wages, reducing their spending power.
Another factor affecting inflation is expectations about rising prices. If businesses believe that there are broad consumer expectations that prices are rising across the board, they may feel more willing to raise their prices without fear that customers will not spend or buy at a competitor. will not decide to do so. It may also prompt employees to demand higher wages from employers as their cost of living has risen, leading to an inflationary cycle of wage-value increases.
We’ve heard a lot about how increased inflation is supposed to be temporary. What do most economists think?
Most economists believe inflation should begin to ease this year, but remains above pre-pandemic levels in 2023. As is often the case among economists, there is disagreement about the level at which price growth will be stable.
How does inflation affect mortgage rates?
Housing prices have soared during the pandemic due to a combination of low mortgage-interest rates, strong demand for building materials and construction workers, and lack of supply. But mortgage rates recently hit their highest level in more than three years, something that could ultimately dampen housing demand.
How does inflation affect the stock market?
Increased inflation will cause the Fed to raise interest rates further, which in turn raises borrowing costs and slackens growth to ease price pressures – fostering market volatility as businesses, consumers And the Fed tries to navigate uncertainties about the economy.