Inflation, explained: why prices keep rising and who’s to blame

Let’s start with the simplest version: inflation occurs when prices rise broadly.

That “broadly” matters: at any given time, the price of a commodity fluctuates based on changing tastes. Someone makes a viral tiktok about Brussels sprouts and suddenly everyone has to have them; Boom, seedling prices rise. Meanwhile, sellers of last season’s trendy veg, cauliflower, are practically offering their wares. Such ups and downs are continuous.

However, inflation occurs when the actual average price Everything Consumers buy. Food, houses, cars, clothes, toys, etc. To meet those needs, wages must also rise.

This is not always a bad thing. In the United States, for the past 40 years (and especially this century), we’ve lived in a well-oiled consumer-driven economy with pretty low-and-slow levels of inflation. About 2% per year, if that. Sure, the prices of some things like housing and health care are higher than ever, but other things like computers and TVs are much cheaper — so the average for all things is relatively stable.

still with me?

Well, let’s cut to today, and why inflation is all over the news.

When inflation is a bad word

Inflation becomes problematic when low and slow simmers are heated to a boil. You hear economists talk about the economy “overheating.” For various reasons, mostly stemming from the pandemic, the global economy is at a hard boil right now.

Economists use two main gauges to track inflation in the United States, and while both eased between June and July, they still hit their highest levels in four decades.

The Consumer Price Index rose 8.5% in July. The Federal Reserve’s preferred personal consumption expenditures price index rose 9.8% in July from the same period a year earlier.

And here Econ 101 merges a bit with Psych 101. Inflation has a behavioral economics aspect where it can become a self-fulfilling prophecy. When prices rise long enough, consumers begin to expect price increases. You buy more goods today if you think it will cost more tomorrow. That has the effect of increasing demand, which causes prices to rise further. And so on. And so on.

This can be especially tricky for the Fed, whose main job is to control the money supply and keep inflation in check.

How did we get here?

Blame the epidemic. And Russia’s war on Ukraine.

In the spring of 2020, as Covid-19 spread, it was like a yank A plug on the global economy. Factories closed all over the world; People stopped eating in restaurants; Airlines grounded flights. Millions of people were laid off as business disappeared practically overnight. In February 2020, the unemployment rate in America rose from about 3.5% to about 15%.

This is the sharpest economic contraction on record.

At the same time, the Fed implemented emergency stimulus measures to keep financial markets from tanking. The central bank dropped interest rates to zero and began pumping tens of billions of dollars each month into the markets by buying corporate debt. By doing so, the bank prevents a full-scale financial meltdown. But keeping those easy-money policies in place for the past 20 months has also fueled — you guessed it — inflation.

Consumer price inflation hit a new 40-year high in March
By early summer 2020, demand for consumer goods began to recover. Quickly. Congress and President Joe Biden passed a historic $1.9 trillion stimulus bill in March that would suddenly flood Americans with cash and unemployment aid. People started shopping again. Demand went from zero to 100, but supply couldn’t bounce back that easily.

When you pull the plug on the global economy, you can’t plug it back in and expect it to start humming along at the same pace as before.

Take cars for example. Automakers started the Covid crisis and did what any smart business would do – temporarily shut down to mitigate losses. But shortly after the pandemic closed factories, it boosted demand for cars as people worried about exposure on public transport and avoided flying. Automakers (and car buyers) had whiplash.
Automakers' problems are worse than we thought

Cars require a huge number of parts from a huge number of different factories around the world to be built by highly skilled workers in other parts of the world. Getting all those discrete operations back online will take time, and keeping workers from getting sick will take even longer.

Economists describe inflation as too much money chasing too few goods. Exactly what happened in the cars. and houses. and peloton bikes. And any other merchandise that has become hot ticket items.

How is the supply chain involved in all this?

“Supply chain disruptions” – this is another one you’re looking at, right?

Let’s go back to the car example.

We know that high demand + limited supply = prices will rise.

But high demand + limited supply + production delays = prices will rise even further.

All modern cars rely on different computer chips to function. But those chips are used in cellphones, appliances, TVs, laptops and dozens of other things that, unfortunately, are in high demand at the same time.

This is just one example of the disconnect in the global supply chain. As new cars were slow to roll in, demand for used cars shot through the roof, driving up overall inflation. In some cases, car owners have been able to sell their used cars for more than what they paid a year or two ago.

What happens next?

Prices and wages may start to ease, but may rise for a while. For how long, and for how long, depends on a myriad of variables around the world.

Russia’s invasion of Ukraine dashed hopes that prices could drop significantly in 2022.

The conflict has rallied commodity and oil markets, raising food and gasoline prices around the world. That compounds supply chain headaches, leading to further shortages of critical foodstuffs and oil.
Lockdowns in China earlier this summer, meanwhile, essentially shut down the world’s largest port. Corporations also bear some of the blame, as many large companies raise prices to protect their profits.

And there’s no telling what kind of new shocks — a resurgent Covid mutation, a massive shipping container getting stuck in a waterway, a natural disaster — might set back progress.

The Fed is poised to move quickly on interest rates

There is no single government or central bank to correct the inflation caused by those global constraints.

But central banks are doing their best. In the United States, the Fed began raising rates by a quarter of a percentage point in March — its first hike since 2018 — and has raised rates four times this year. There are no signs of them stopping anytime soon.

When money becomes more expensive to borrow, it can take the heat off inflation and return the economy to that nice, gentle simmer. Or so the Fed hopes. Its biggest challenge is deploying interest rate hikes at a pace the economy can tolerate – raising them too much or too soon risks collapsing demand, which could derail economic growth or trigger a recession.

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