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Home / Economy / Why do prices keep going up and what’s the cause of inflation?

U.S. inflation is at its highest rate in 31 years, with consumers seeing prices rise sharply for a variety of goods and services because of persistent supply and labor shortages and strong demand.

Stoked by imbalances in the economy created by the Covid-19 pandemic, inflation is one of the most vexing problems facing economists and government policy makers—from Federal Reserve officials, who set interest rates, to the Biden administration and Congress. The causes are myriad, and the tools that are usually deployed can, in some scenarios, push the economy into a recession as a way of taming price pressures.

Here’s how inflation works:

What is inflation and why does it matter to you?

Inflation reflects the broad rise of prices or the fall in the value of money. It generally results from too much demand chasing too few goods or limited services, resulting in price increases. Inflated prices don’t necessarily hurt the economy as a whole, and only those consumers making purchases experience the increase.

For example, for much of the past year new auto prices have rocketed upward because of vehicle shortages, driven by a lack of key components such as semiconductors. While there have been ripple effects—such as more demand and higher prices for used cars, given the shortage of new ones—the increase in auto prices doesn’t necessarily affect you unless you need to buy a vehicle.

Likewise, higher prices in one sector doesn’t necessarily lead to general inflation across the economy. But price increases across a range of categories will weaken consumers’ spending power.

What is causing inflation right now?

The current bout of inflation has several identified causes, many of them linked to the pandemic. For one, consumers are flush with savings from government stimulus programs and depressed services spending from restrictions on businesses, leading them to open the spigot for goods that are in scarce supply.

There also are fewer workers in the labor market, encouraging those who are working to demand raises and crimping overall productivity. These factors and many others are driving up costs.

Energy prices, including gasoline, have gone up as oil-and-gas production lags behind a return of consumer demand coming out of the pandemic. This return of demand has also led to supply-chain disruptions. Truck drivers, seaport slots and warehouse spaces are all in short supply, leading to costly delays and rising shipping rates for goods.

These added costs, at every step from production to sale, lead to price increases for consumers, with some companies seizing on a rare opportunity to raise prices.

Just how fast are prices rising?

The consumer-price index, a key reading of inflation, is up 6.2% from a year ago, according to the Labor Department’s report for October. With food and energy removed from the picture—prices in those categories can be volatile—CPI is up at a slightly lower rate of 4.6%. The readings, however, show that price increases are widespread and well above policy makers’ targets for annual inflation, which hover around 2% on average.

That pace is the fastest 12-month gain for inflation since 1990, which means a third of the nation has never seen a similar stretch of price gains.

How is inflation measured?

There are different ways of measuring inflation, even among government agencies. The shorthand version comes from the already mentioned CPI, measured by the Labor Department. It is calculated using a survey of households and only covers spending on goods and services. It excludes expenditures that aren’t paid for directly, such as medical care paid for by a person’s health insurance. Its limited set of expenditures can make CPI more volatile.

The personal-consumption-expenditures price index, or PCE, takes into account a broader range of expenditures—and feedback from businesses—to provide a more expansive picture of price changes. The core PCE, excluding food and energy, is the Fed’s preferred measurement of inflation. The Commerce Department releases its PCE estimate monthly as part of its income and spending report.

What goods or services are driving the increase in prices?

Prices are going up throughout the economy, but not uniformly. Gasoline prices in October went up nearly 50% from the same month a year ago, putting them at levels last seen in 2014. Grocery prices climbed 5.4%, with pork prices up 14.1% from a year ago, the biggest increase since 1990.

Prices for new vehicles jumped 9.8% in October, the largest rise since 1975, while prices for furniture and bedding leapt by the most since 1951. Prices for tires and sports equipment rose by the most since the early 1980s. Not every single good is affected by inflation: Prices fell for airline fares and alcohol last month.

I’ve noticed it costs a lot more to fill up my vehicle with gasoline. Can the government help?

In response to higher oil and gasoline prices, the Biden administration is considering whether to release oil from the U.S. Strategic Petroleum Reserve. The reserve holds more than 600 million barrels of oil in four underground storage caverns and salt domes along the Texas and Louisiana coasts. Congress authorized its creation in 1975, in the wake of the Arab oil embargo, as a buffer against supply shocks from oil exporters.

Releasing from the reserve would be aimed at increasing supply and easing gasoline prices.

The Trump administration considered a similar move in 2018 before opting against it. Congress has started draining the reserve as a way to raise cash to pay for tax cuts and other spending. Under congressional authorization the Energy Department has run seven sales since 2017, offloading more than 60 million barrels, or about 8.6% of what had been in the reserve, according to department figures.

Wages are also rising, right? But are they rising enough to maintain people’s purchasing power given the pace of inflation?

In this tight labor market, workers are getting raises. But in real-dollar terms, their money isn’t going as far as it used to. Average hourly earnings went up in October by 0.4% from the month before, but inflation went up by 0.9% over the same period, resulting in a 0.5% decline in real wage growth. On an annualized basis, average hourly wages are up 4.9%, less than the 6.2% rise in inflation.

Another factor affecting inflation is expectations about rising prices. If businesses believe there are widespread consumer expectations that prices are going up across the board, they may feel more inclined to raise their prices without fear that customers won’t spend or decide to shop at a competitor. This can also lead employees to ask for higher wages from employers because their cost of living has gone up, which can lead to an inflationary cycle of wage-price increases.

We’ve heard a lot about how elevated inflation is supposed to be temporary. What do most economists think?

Most economists believe inflation should ease next year, as supply chains normalize and energy prices stop rising. But, as is often the case among economists, there is disagreement about the level where price increases will stabilize. Fed officials think inflation will return to between 2% and 2.5% next year.

Financial markets appear less confident that inflation will settle at those levels, though. On Friday, inflation-indexed securities were projecting consumer-price inflation at 3% through 2023 before falling to between 2% and 2.5% in later years.

How does rising inflation affect mortgage rates?

Housing prices have risen during the pandemic because of a combination of low mortgage-interest rates, strong demand and supply crunches for building materials and construction workers. Mortgage rates have stayed low as the Fed has kept interest rates near zero as part of its effort to support the economy. Economists expect mortgage rates to rise some as the Fed increases interest rates, likely starting that process by the middle of next year. Still, interest cost for purchasing a house is expected to remain low for the foreseeable future, in part because the Fed isn’t expected to raise interest rates by a lot.

How does inflation affect the stock market?

In the short-term, inflation can boost the stock market. Companies may report higher profits based on inflationary price increases. Nearly two out of three of the biggest U.S. publicly traded companies have reported fatter profit margins so far this year than they did over the same stretch of 2019, before the Covid-19 outbreak, data from FactSet show.

But that honeymoon only ends well if inflation is transitory, or temporary. Entrenched inflation would lead to the Fed raising interest rates more, which in turn raise borrowing costs and crimp growth to tame price pressures. Many investors expect a market correction if there are continued reports of high inflation over the next several months, because that could cause the Fed to act more aggressively.

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