The government reported on Friday that consumer prices rose 8.6 percent during the year to May, the fastest rate of increase in four decades.
Americans are facing more expensive food, fuel, and housing, and some are looking for answers about what is causing the prices to rise, how long it can take, and what can be done to fix it.
There are few easy answers or painless solutions when it comes to inflation, which has risen around the world as supply shortages clash with hot consumer demand. It is difficult to predict how long today’s price hike will last, and the main tool in combating it is rising interest rates, which cool inflation by slowing the economy, potentially abruptly.
Here’s a guide to understanding what’s going on with inflation and how to think about price gains as you navigate this tricky time in the U.S. and world economy.
What is driving inflation
It may be helpful to think that the causes of current inflation fall into three related categories.
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Strong demand. Consumers spend a lot. In the early days of the pandemic, households accumulated savings while trapped at home, and government support that continued until 2021 helped them save even more money. Now people are taking jobs and earning salary increases. All of these factors have padded bank accounts for the home, allowing families to spend everything from grills in the backyard and beach vacations to cars and kitchen tables.
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Too few goods. As families have taken pandemic savings and tried to buy pickup trucks and computer screens, they have encountered a problem: there have been too few goods to circulate. Pandemic-related factory closures, global shipping delays, and reduced production have become a shortage of parts and products. As demand has outpaced supply of goods, companies have been able to charge more without losing customers.
China’s latest blockades are now exacerbating supply chain thicknesses. At the same time, the war in Ukraine is reducing the global supply of food and fuel, increasing general inflation and increasing the cost of other products and services. Gasoline prices are averaging about $ 5 a gallon nationwide, compared to just over $ 3 a year ago.
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Pressures from the services sector. More recently, people have been shifting their spending away from things and experiences as they adjust to life with the coronavirus, and inflation has been rising in the service industries. Rents are rising rapidly as Americans compete for a limited supply of apartments, restaurant bills are rising as food and labor costs rise, and airline and room tickets are rising. ‘hotel costs more because people want to travel and because fuel and labor are more expensive.
You may be wondering: what role does corporate greed play in all this? It is true that companies have been making unusually large profits as they raise prices more than necessary to cover rising costs. But they are able to do so in part because demand is so strong: consumers are spending directly through price increases. It is unclear how long this pricing power will last. Some companies, such as Target, have already indicated that they will start lowering the prices of some products as they try to eliminate inventory and retain customers.
Understand inflation and how it affects you
How is inflation measured?
Economists and policymakers are looking closely at the two primary indicators of U.S. inflation: the consumer price index, released on Friday, and the personal consumption spending index.
The CPI captures how much consumers pay for the things they buy, and it comes out earlier, making it the country’s first clear view of what inflation did last month. Index data is also used to obtain PCE figures.
The PCE index, which will be released on June 30, tracks how much things really cost. For example, it counts the price of health care procedures even when the government and insurance help pay for them. It tends to be less volatile and is the index the Federal Reserve is looking at when it tries to achieve an average inflation rate of 2% over time. In April, the PCE index rose 6.3 percent from a year earlier, more than three times the central bank’s target.
Fed officials are paying close attention to changes in inflation month by month to get an idea of their momentum.
Politicians are also especially in tune with the so-called core inflation measure, which eliminates food and fuel prices. While groceries and gas make up a large part of family budgets, they also raise the price in response to changes in global supply. As a result, they do not give such a clear reading of the inflationary pressures underlying the economy, which the Fed believes can do anything.
“I’m going to look at a consistent series of declining monthly impressions on core inflation before I feel more confident that we’re getting to the kind of inflation path that will get us back to our 2 percent target,” Lael Brainard said. , vice president of the Fed and one of its key public messengers, during an interview with CNBC last week.
What can slow down rapid price gains?
Anyone can predict how long prices will continue to rise rapidly: inflation has repeatedly confused experts since the pandemic took hold in 2020. But according to current price drivers, there seems likely to be some results.
On the one hand, rapid inflation seems unlikely to go away on its own. Wages are rising much faster than normal. This means that unless companies are suddenly more efficient, they will probably try to keep raising prices to cover their labor costs.
Frequently asked questions about inflation
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What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar won’t go as far tomorrow as it does today. It is usually expressed as the annual change in the prices of everyday goods and services such as food, furniture, clothing, transportation and toys.
What causes inflation? It may be the result of increased consumer demand. But inflation can also rise and fall depending on developments that have little to do with economic conditions, such as limited oil production and supply chain problems.
Is inflation bad? It depends on the circumstances. Rapid price increases pose problems, but moderate price gains can lead to higher wages and job growth.
Can inflation affect the stock market? Rapid inflation often leads to stock problems. Historically, financial assets in general have gone bad during inflation hikes, while tangible assets such as homes have maintained their value better.
As a result, the Fed is raising interest rates to curb demand and curb wage and price growth. The central bank’s political response means that the economy is almost certainly heading for a slowdown. Higher borrowing costs have already begun to cool the housing market.
The question, and the great uncertainty, is how much Fed action will be needed to control inflation. If America is lucky and the supply chain shortages are reduced, the Fed could drop the economy gently, slowing the labor market enough to moderate wage growth without causing a recession.
In this optimistic scenario, often called a soft landing, companies will be forced to lower their prices and reduce their big profits as supply and demand balance and compete for customers again.
But supply problems are also likely to persist, leaving the Fed with a more difficult task: raising rates more drastically to curb demand enough to control price increases.
“The road to a soft landing is very narrow, narrow to the point where we expect a recession as a baseline,” said Matthew Luzzetti, chief economist at Deutsche Bank. This is partly because consumer spending shows few signs of breaking so far.
Mr.’s team Luzzetti has estimated that households still have about $ 2.3 trillion in excess savings to help them overcome higher rates and prices.
“There are still deep pockets of repressed demand,” Anthony G. Capuano, chief executive of Marriott International Hotel, said at a June 7 event. “Unlike previous economic cycles and the economic recession, here’s this added dimension, which was that people were locked up for 12 to 24 months.”