The Story Behind Stubborn Inflation
Even as the economy is close to full recovery from the COVID-19 pandemic that swept the world two years ago, US inflation rates remain high. As of today (May 30, 2023), the inflation rate is at 4.93%. While this is 0.05% lower than what it was at 4.98% last month in April—and way lower than its peak at 9.1% in June—, it still floats far above the 2% target rate that the Fed set back in 2012.
There are usually two stories behind inflation: demand-pull inflation and cost-pull inflation. Demand-inflation happens when consumer demand exceeds supply. Cost-pull inflation happens when there is a sudden supply shock, resulting in a decrease in goods and services provided. The question on the table is which of these two explains high consumer prices now.
The story used to be cost-pull inflation. The onset of the Russian-Ukraine war back in February fueled product shortages in the food, energy, and mineral markets that resulted in cost increases. The conflict also interfered with global supply chains, with major obstructions to the flow of goods into and out of the warring countries.
In recent months, the prices of input goods—like oil and food ingredients— that were once so high have started to gradually fall. The cost of transportation has also followed suit. The initial shocks of the Ukraine war and the pandemic have started to fade as the world readjusts and reorganizes itself. American consumer demand has shifted back to services and away from goods. This has led shipping rates to fall by more than 80% of what it was at its peak. Port congestion and hold ups along both coasts have also started to clear up.
The story now is demand-pull inflation. Households emerging from the pandemic have built up a demand for goods and services. Not only are consumers eager to go out and spend on the things they were unable to during a global health crisis—vacations, cruise trips, concerts, etc.—, they also now have the means to finance their spending sprees. This is all thanks to generous government stimulus measures during the pandemic. Stimulus payments, investment gains, pay raises, and low interest rates place households in a better financial position to buy. Consumer excitement and excess disposable income contribute to a demand surge, which in turn might be keeping inflation high even as supply shocks disappear.
This is the changing story behind stubbornly high inflation. Unfortunately, it seems that as soon as things have started to settle down on the supply side, forces on the demand side have acted up to keep consumer prices high. In hopes of taming inflation, The Federal Reserve raised interest rates by a quarter of a percentage point back in March. Time can only tell whether this will provide much help in reigning back inflation rates. If not, economists remain hopeful that with the coming Biden-McCarthy budget deal and the proposed spending cuts, there will be clear improvements.
