EXPLAINER: Why US inflation is so high, and when it may ease
WASHINGTON (AP) — At first, it didn’t even register as a threat. Then it seemed like a temporary annoyance.
Now, inflation is flashing red for the Federal Reserve’s policymakers — and delivering sticker shock to Americans at the used car lot, the supermarket, the gas station, the rental office.
On Wednesday, the Labor Department reported that consumer prices jumped 7% in December compared with 12 months earlier — the hottest year-over-year inflation since June 1982. Excluding volatile energy and food prices, what is called “core” inflation rose 5.5% over the past year, the fastest such pace since 1991.
Bacon prices are up nearly 19% from a year ago, men’s coats and suits nearly 11%, living and dining room furniture more than 17%. Renting a car will cost you 36% more, on average, than it did in December 2020.
“Prices are increasing broadly throughout the economy, and the Federal Reserve has been caught off-guard by the extent of inflation,″ said Gus Faucher, chief economist at PNC Financial.
It wasn’t supposed to be this way — not with the coronavirus pandemic keeping people hunkered down at home and triggering a devastating recession beginning in March 2020. Barely more than a year ago, the Fed had forecast that consumer prices would end 2021 only about 1.8% higher than they were a year earlier, below even its annual 2% inflation target.
Yet after having been an economic afterthought for decades, high inflation reasserted itself last year with astonishing speed. In February 2021, the Labor Department’s consumer price Index was running just 1.7% ahead of a year earlier. From there, the year-over-year price increases accelerated steadily — 2.6% in March, 4.2% in April, 4.9% in May, 5.3% in June. By October, the figure was 6.2%, by November 6.8%.
At first, Fed Chair Jerome Powell and others characterized higher consumer prices as merely a “transitory” problem — the result, mainly, of shipping delays and temporary shortages of supplies and workers as the economy rebounded from the pandemic recession much faster than anyone had anticipated.
Now, many economists expect consumer inflation to remain elevated at least through this year, with demand outstripping supplies in numerous areas of the economy.
And the Fed has radically changed course. As recently as September, Fed policymakers had been divided over whether to raise rates even once this year. But last month, the central bank signaled that it expects to raise its short-term benchmark rate, now pinned near zero, three times this year in an effort to quell inflation. And many private economists expect as many as four Fed rate hikes in 2022.
“If we have to raise interest rates more over time,” Powell told the Senate Banking Committee on Tuesday, “we will.”
WHAT’S CAUSED THE SPIKE IN INFLATION?
Much of the surge is actually a consequence of healthy economic trends. When the pandemic paralyzed the economy in the spring of 2020 and lockdowns kicked in, businesses closed or cut hours and consumers stayed home as a health precaution, employers slashed a breathtaking 22 million jobs. Economic output plunged at a record-shattering 31% annual rate in last year’s April-June quarter.
Everyone braced for more misery. Companies cut investment. Restocking was postponed. A brutal recession ensued.
But instead of sinking into a prolonged downturn, the economy staged an unexpectedly rousing recovery, fueled by vast infusions of government aid and emergency intervention by the Fed, which slashed interest rates, among other things. By spring this year, the rollout of vaccines had emboldened consumers to return to restaurants, bars, shops and airports.
Suddenly, businesses had to scramble to meet demand. They couldn’t hire fast enough to fill job openings — a near record 10.6 million in November — or buy enough supplies to meet customer orders. As business roared back, ports and freight yards couldn’t handle the traffic. Global supply chains became snarled.
Costs rose. And companies found that they could pass along those higher costs in the form of higher prices to consumers, many of whom had managed to sock away a ton of savings during the pandemic.
But critics, including former Treasury Secretary Lawrence Summers, blamed in part President Joe Biden’s $1.9 trillion coronavirus relief package, with its $1,400 checks to most households, for overheating an economy that was already sizzling on its own.
The Fed and the federal government had feared an agonizingly slow recovery like the one that followed the Great Recession of 2007-2009.
“In retrospect, it was more than what was needed,” said Ellen Gaske, an economist at PGIM Fixed Income. “I point a finger very strongly at the nature of fiscal policy at this time. It was not just the size of the (relief) packages, but those direct cash payments to households added purchasing power very directly. And when you pushed that up against the supply disruptions because of COVID, the pressure valve was higher inflation.’’
HOW LONG WILL IT LAST?
Elevated consumer price inflation will likely endure as long as companies struggle to keep up with consumers’ demand for goods and services. A recovering job market — employers added a record 6.4 million jobs last year — means that many Americans can continue to splurge on everything from lawn furniture to electronics.
Many economists see inflation staying well above the Fed’s 2% target this year. But relief from higher prices might be coming. Jammed-up supply chains are beginning to show some signs of improvement, at least in some industries. The Fed’s sharp pivot away from easy-money policies toward a more hawkish, anti-inflationary policy could slow the economy and reduce consumer demand. There will be no repeat of last year’s COVID relief checks from Washington.
Inflation itself is eating into household purchasing power and might force some consumers to shave back spending.
“I’m expecting it will largely work itself out by the second half of this year,” PGIM’s Gaske said. “Ás supply comes back on online, I think some of those pressures will get alleviated.’’
COVID’s highly transmissible omicron variant could muddy the outlook -- either by causing outbreaks that force factories and ports to close and thereby disrupting supply chains even more or by keeping people home and reducing demand for goods.
HOW ARE HIGHER PRICES AFFECTING CONSUMERS?
A strong job market is boosting wages, though not enough to compensate for higher prices. The Labor Department says that hourly earnings for all private-sector employees fell 1.7% in November from a year earlier after accounting for higher consumer prices. But there are exceptions: After-inflation wages were up nearly 14% for hotel workers and 7% for restaurant employees.
Partisan politics also colors the way Americans view the inflation threat. With a Democrat in the White House, Republicans were nearly three times more likely than Democrats (47% versus 16%) to say that inflation was having a negative effect last month on their personal finances, according to a survey of consumers by the University of Michigan.