WASHINGTON —
Last year was a nasty surprise. And it was supposed to be temporary. But now inflation has become a financial burden for millions of Americans when it comes to filling up gas, paying for groceries, buying clothes, negotiating a car or paying rent.
During the last 12 months ending in January, inflation rose to 7.5%, its fastest annual growth since 1982, the Labor Department reported Thursday. Even if you don’t factor in volatile food and electricity prices, so-called core inflation soared 6% over the past year. It was also the sharpest increase in four decades.
Consumers felt rising prices in all aspects of daily life. In the past year, the price of used cars and trucks has risen 41%, gasoline 40%, bacon 18%, bedroom furniture 14% and women’s dresses 11%.
The Federal Reserve did not anticipate such a severe or persistent wave of inflation. In December 2020, the Fed had forecast that consumer inflation would remain below the 2% annual target and end 2021 at about 1.8%.
But after going virtually unnoticed for decades, high inflation resurfaced this year with breakneck speed. In February 2021, the government’s consumer price index was just 1.7% above its level a year earlier. From then on, year-on-year price increases steadily accelerated: 2.7% in March, 4.2% in April, 4.9% in May, 5.3% in June.
For October, the figure was 6.2%, for November it was 6.8% and in December it reached 7.1%.
For months, Fed Chairman Jerome Powell and other officials have described higher consumer prices as merely a “transitional” problem, a result mainly attributable to delayed shipments and temporary supply and labor shortages in a At a time when the economy was recovering from the recession caused by the pandemic at a faster rate than anyone had anticipated.
Now, many economists expect consumer inflation to remain high for much of the year, with demand outstripping supply in various areas of the economy.
“Inflation remains the economy’s biggest short-term challenge,” said Jim Baird, chief investment officer at Plante Moran Financial Advisors. “Although price pressure is expected to ease as the year progresses, inflation will remain above the Fed’s 2% target for some time.”
So the Federal Reserve has radically changed its strategy. Last month, the central bank signaled that it will begin a series of increases in its interest rates starting in March. In doing this, the Fed distances itself from the extremely low rates that helped revive the economy after the devastating recession that the pandemic caused, but have also contributed to the rise in consumer prices.
1) WHAT CAUSED THE INCREASE IN INFLATION?
It was good news, for the most part. When the pandemic paralyzed the economy in mid-2020 and lockdowns took effect, businesses closed or reduced their hours of operation and consumers stayed home to protect their health, employers cut a staggering 22 million jobs of work.
Economic output plunged at an annual rate of 31% during the April-June quarter of 2020.
Everyone braced for more suffering. The companies reduced their investments and postponed their resupply. The result was a devastating recession.
Instead of collapsing into a protracted crisis, however, the economy staged an unexpected recovery, buoyed by huge government aid injections and emergency intervention by the Fed, which cut interest rates and implemented other measures.
Around the middle of last year, vaccination campaigns gave consumers the confidence to return to restaurants, bars, stores and airports.
Suddenly, businesses were struggling to meet demand. They couldn’t hire staff fast enough to fill all their vacancies — 10.9 million in December — or buy enough supplies to meet orders. As business recovered, ports and loading stations struggled to handle traffic. Global supply chains were overwhelmed.
Increased demand and tight supplies resulted in increased costs. And the companies found that they could pass on those higher costs through higher prices to consumers, many of whom had managed to rack up considerable savings during the pandemic.
But critics, including former Treasury Secretary Lawrence Summers, pointed out that President Joe Biden’s $1.9 trillion coronavirus aid package, with its $1,400 checks to most families, was partially responsible for overheat an economy that was already in an intense rebound on its own.
The Fed and the federal government feared that the recovery would be maddeningly slow like the one that followed the Great Recession that hit the country from 2007 to 2009.
2) HOW LONG WILL IT LAST?
High consumer price inflation is likely to continue as long as companies struggle to meet demand for products and services.
A recovering job market — employers added 6.7 million jobs last year and another 467,000 more in January — means many Americans can continue to splurge on everything from lawn furniture to electronics.
Many economists forecast that inflation will remain well above the Fed’s target of 2% this year. But relief from high prices could be on the way.
Stuck supply chains have begun to show some signs of improvement, at least in certain industries. The radical change in the Fed’s strategy, moving away from easy money policies to implement more inflation-fighting measures, could slow the economy and reduce demand. Washington will no longer send relief checks for COVID-19.
By itself, inflation is reducing purchasing power and that could force some consumers to cut back on spending.
Omicron or some other variant of COVID-19 could darken the picture, either by causing outbreaks that force factories and ports to close or further disrupt supply chains, or by keeping people at home, thus reducing demand for products.
“It’s not going to be an easy decline,” said Sarah House, an economist at Wells Fargo. “We anticipate consumer price inflation to remain at around 4% towards the end of the year. That’s still above what the Fed would like and certainly way above what consumers are used to seeing.”
3) HOW DO HIGHER PRICES AFFECT CONSUMERS?
A strong labor market is boosting wages, though not enough to offset rising prices.
The Labor Department says hourly earnings among private-sector employees fell 1.7% last month from a year earlier after taking into account higher consumer prices. But there are exceptions: Post-inflation wages rose more than 10% among hotel employees and more than 7% for bar and restaurant workers in December compared with a year earlier.
Partisan politics also influences how Americans perceive the threat of inflation.
Now that there is a Democratic administration in the White House, Republicans were almost three times as likely as Democrats (45 to 16%) to say that inflation had a negative effect on their personal finances last month, according to a survey by the University of Michigan.