Inflation is starting to sound like that unexpected – and unwanted – guest who just doesn’t want to go.
For months, many economists had been sending out a reassuring message that a surge in consumer prices, something the United States had lacked for a generation, would not last long. It would prove to be “transient,” in the soothing words of Federal Reserve Chairman Jerome H. Powell and White House officials, as the economy shifts from virus-related chaos to something closer to normal. .
Yet, as any American who’s bought a carton of milk, a gallon of gasoline, or a used car might tell you, inflation has set in. And economists are now expressing a more disheartening message: The price hike will likely last until next year, if not beyond.
The government reinforced that message on Friday with its report that the consumer price index climbed 6.8% last month from a year earlier – the biggest 12-month jump since 1982.
And the sticker shock hits where families tend to feel it the most. At the breakfast table, for example, bacon prices are up 21% from last year, egg prices by 8%. Gasoline jumped 58%. Furnishing your living room, dining room or kitchen will cost you 14% more than a year ago. Used vehicles? Up 31%.
And although wages are rising sharply for many workers, they are nowhere near enough to keep up with prices. Last month, the average hourly wage in the United States, after controlling for inflation, was actually down 2.4% from November 2020.
Wells Fargo economists joked that the Labor Department’s CPI – the consumer price index – should stand for “consumer pain index.” Unfortunately for consumers, especially low-income households, this all coincides with their higher spending needs just before the holiday season.
The price suppression intensifies the pressure on the Fed to move away from years of easy money policies more quickly. And it poses a threat to President Biden, the Congressional Democrats, and their ambitious spending plans.
What caused the prices soaring?
This is largely the flip side of very good news. Struck by COVID-19, the U.S. economy collapsed in the spring of 2020 as closures took effect, businesses shut down or cut hours, and consumers stayed at home as a health precaution. Employers cut 22 million jobs. Economic output plunged at a record annual rate of 31% in the April-June quarter of last year.
Everyone has prepared for more misery. Companies are reducing their investments. Replenishment has been postponed. And a brutal recession ensued.
Yet instead of slipping into a prolonged downturn, the economy staged an unexpected recovery, fueled by massive government spending and a host of emergency measures from the Fed. In the spring, the vaccine rollout encouraged consumers to return to restaurants, bars and shops.
Suddenly companies had to scramble to meet demand. They couldn’t hire quickly enough to fill vacancies – a record close to 11 million in October – or buy enough supplies to fill customer orders. As business picked up, ports and freight yards could no longer handle the traffic. Global supply chains have become harassed.
The costs have gone up. And companies have found they can pass those higher costs on in the form of higher prices to consumers, many of whom had managed to save a ton in savings during the pandemic.
“A significant part of the inflation that we are seeing is the inevitable outcome of exiting the pandemic,” said Jason Furman, economic adviser to the Obama White House and now to the Harvard Kennedy School.
Furman suggested, however, that misguided politics also played a role. Policymakers were so determined to avoid an economic collapse that they “systematically underestimated inflation,” he said.
“They poured kerosene on the fire.
A flood of government spending – including Biden’s $ 1.9 trillion coronavirus relief program, with its $ 1,400 checks to most households in March – overstimulated the economy, Furman said.
“Inflation is much higher in the United States than in Europe,” he noted. “Europe is going through the same supply shocks as the United States, the same supply chain problems. But they didn’t do as much of a stimulus.
Biden acknowledged that inflation was hurting Americans’ wallets and said containing inflation was a priority. But he said his $ 1 trillion infrastructure program, including spending on roads, bridges and ports, will help ease supply bottlenecks and hence inflationary pressures.
How long will it last?
Consumer price inflation is likely to persist as long as businesses strive to meet consumer demand for goods and services. A resurgent job market – employers created 6.1 million jobs this year – means Americans can continue to splurge on everything from patio furniture to new cars.
“The demand side of the US economy will continue to be something to see,” said Rick Rieder, investment manager for global fixed income at BlackRock, “and companies will continue to afford the luxury of passing on the price”.
Megan Greene, chief global economist at the Kroll Institute, suggested that inflation and the overall economy would eventually return to something closer to normal.
“I think it will be transitory,” she said of inflation. “But economists have to be very honest about the definition of transient, and I think it could easily go on for another year.”
“We need a lot of humility to say how long this lasts,” Furman said. “I think he’s been with us for a while. The inflation rate is going to come down from the lightning pace this year, but it’s still going to be very, very high by historical standards that we’re used to.
Are we going to experience a 1970s-style “stagflation” return?
Soaring consumer prices raise the specter of a return to the ‘stagflation’ of the 1970s. This was when higher prices coincided with high unemployment rates, despite what economists did. conventional thought to be possible.
The situation today looks very different. Unemployment is relatively low and households are generally in good financial health. The Conference Board, a research group on business, found that consumer inflation expectations last month were the highest they have been since July 2008. But their overall confidence remains at high levels.
Economic growth, after slowing from July to September in response to the highly contagious Delta variant of the coronavirus, is expected to rebound in the last quarter of 2021.
“Most economists expect growth to accelerate in the fourth quarter,” Greene said. “So that does not suggest that we are facing both slower growth and higher inflation. We are simply facing higher inflation.
What should policy makers do?
The pressure is on the Fed, responsible for controlling inflation, to control prices.
The central bank began to counter inflationary pressures by cutting its $ 120 billion monthly bond purchases by $ 15 billion per month. These purchases, launched last summer, were aimed at maintaining long-term interest rates in order to stimulate borrowing and spending.
But with inflationary pressures lingering longer than Powell’s Fed expected, the central bank is expected to make a big announcement as early as next week that it will step up its withdrawal from bond purchases.
This would put the Fed on track to start raising its key short-term interest rate as early as the first half of next year. This rate has been close to zero since March 2020, when COVID-19 plunged the economy into a deep recession. A rate hike that would soon be much earlier than expected, just this summer, when Fed policymakers predicted they wouldn’t do so until the end of 2023.
“We’ve been battling inflation that hasn’t existed since the 1990s,” said Diane Swonk, chief economist at accounting and consulting firm Grant Thornton, “and now we’re talking about fighting real inflation.”