Why Is US Inflation So High, And Will It Ease?

The So-Called Transitory Issue Now Looks To Be Around For A While.

Initially, it didn’t even register as a risk. Then it seemed like a passing annoyance.

Now, for the Federal Reserve's officials, inflation is flashing red — and it's delivering sticker shock to Americans at the used car lot, grocery store, petrol station, or rental office.

On Wednesday, the Labor Department said that consumer prices increased 7% in December compared to a year earlier, which was the biggest yearly inflation since June 1982. Core inflation increased 5.5% over the last year, which was the quickest such rate since 1991 excluding volatile energy and food costs.

Bacon is up over 19% from last year, mens coats and suits about 11%, living and dining room furniture more than 17%. On average, renting a vehicle cost you 36% more in December 2021 than it would have 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 chief economist at PNC Financial, Gus Faucher.

It wasn't supposed to be like this, with the coronavirus pandemic keeping people indoors and triggering a terrible recession that began in March 2020.The Fed had predicted that consumer prices would rise just 1.8% higher in 2021 than they did in 2020, well short of its 2% annual inflation target.

After decades of being an economic afterthought, high inflation has reasserted itself with alarming speed in recent months. The consumer price Index at the Labor Department was 1.7% higher than a year earlier in February 2021.  From there, the year-over-year price increases escalated rapidly — 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%.

Fed Chair Jerome Powell and others initially characterized higher consumer costs as a "transitory" issue: the consequence, primarily, of shipping delays and short supplies of materials and labor as the economy recovered from the pandemic recession faster than anyone had anticipated.

Now, many experts anticipate that consumer inflation will remain high at least through the year, with demand exceeding supplies in a variety of sectors.

The Fed has taken a sharp turn. The Fed had been divided over whether to raise interest rates once in this period as recently as September. But last month, the central bank indicated that it expects to raise its short-term benchmark rate, which is currently pinned near zero, three times this year in order to fight inflation. Many private economists expect as many as four rate hikes in 2022.

Powell told the Senate Banking Committee, on Tuesday, “If we have to raise interest rates more over time, we will.”

WHAT'S CAUSED THE SPIKE IN INFLATION?

Much of the increase is, in reality, a consequence of positive economic tendencies. When the pandemic weighed down the economy in the spring of 2020 and lockdowns were implemented, businesses shut or reduced hours while customers stayed at home as a health precaution, resulting in the loss of a 22 million jobs. In last year's April-June quarter, gross domestic product fell at an unprecedented 31% yearly rate.

For the next several months, life followed a downward spiral. Companies halted investment. Restocking was put off for some time. A severe recession ensued as a result of it.

Despite this, the economy instead staged an unexpectedly strong recovery, aided by huge injections of government aid and emergency action by the Fed, which cut interest rates, among other things. By springtime this year, vaccines had encouraged customers to return to restaurants, bars, businesses, and airports.

Suddenly, corporations had to scramble to keep up with demand. They couldn't hire fast enough to meet job openings — a near-record 10.6 million in November — or acquire adequate goods to fulfill consumer orders, as ports and freight yards could not handle the traffic. Global supply chains were slowed down.

Costs rose, and businesses discovered that they might increase their prices to consumers, many of whom had been able to save a lot of money during the pandemic.

Critics blamed the $1.9 trillion coronavirus relief package, which provided cash to nearly all American households for overheating an economy that was already hot on its own.  The Fed and the federal government had been concerned about a painfully slow recovery, such as the one that followed the Great Recession of 2007-2009.  Ellen Gaske, an economist at PGIM Fixed Income explained,

“In retrospect, it was more than what was needed ... 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?

As long as businesses are unable to keep up with consumers' demands for products and services, inflation will be high. The resumption of job growth in the United States — employers added 6.4 million jobs last year — indicates that many Americans may continue to spend money on everything from lawn furniture to electronics.

Inflation is expected to remain well above the Federal Reserve's 2% target this year, according to many economists. However, prices could soon begin to drop. Supply chains that have been clogged up are beginning to show some indicators of recovery, at least in select sectors. The Fed's sudden shift away from easy-money policies to a more hawkish, anti-inflationary policy could slow the economy and curb consumer spending. There will be no repeat of last year's COVID assistance checks from Washington.

Inflation is eating away at the purchasing power of individuals' wallets and might lead to more budget cuts.

“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.’’

The highly transmissible omicron variant of the coronavirus may muck up the picture, either by causing outbreaks that necessitate factories and ports to close, disrupting supply chains even more, or by keeping people at home and lowering demand for goods.

HOW ARE HIGHER PRICES AFFECTING CONSUMERS?

Wages are increasing, albeit slowly. The job market is strengthening, yet not fast enough to outweigh rising costs. After accounting for higher consumer prices, hourly earnings for all private-sector employees decreased 1.7% in November from a year earlier, according to the Labor Department. Wages were up nearly 14% for hotel staff and 7% for restaurant workers.

Americans' fears of inflation are also influenced by partisanship. According on a poll of consumers conducted by the University of Michigan, Republicans were nearly three times more likely than Democrats (47% versus 16%) to say that inflation had a negative influence on their personal finances last month.

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