U.S. inflation is at its highest rate in four decades,reaching 8.5% in March from a year ago. Consumers are seeing prices rise sharply for a variety of goods and services because strong demand is colliding with persistent supply shortages.
Inflation is one of the most vexing problems facing economists and government policy makers, and is a factor raising the risk of U.S. recession. The causes are myriad, and the tools usually deployed to tame price pressures can, in some scenarios, push the economy into a recession.
Here’s what to know:
What is inflation?
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, leading to price increases. Inflated prices don’t necessarily hurt the economy as a whole, and only those consumers making purchases experience the increase.
For example, new and used auto prices have risen sharply because of vehicle shortages driven by a lack of components such as semiconductors. The increase in auto prices doesn’t necessarily affect you unless you want to buy a vehicle.
Higher prices in one sector also don’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?
The current bout of inflation has several causes, many linked to the pandemic. For one, consumers have been flush with savings from government stimulus programs and depressed services spending as a result of restrictions on businesses, leading them to open the spigot for goods that are in scarce supply.
Supply-chain disruptions have also persisted across the global economy, with Russia’s invasion of Ukraine and the recent rise of Covid-19 cases in China adding additional pressures. Energy prices, including gasoline, have gone up. Truck drivers, seaport slots and warehouse spaces are all in short supply, leading to costly delays and rising shipping rates for goods.
Fewer workers are in the labor market, encouraging those who are working to demand raises. And low interest rates from the Federal Reserve have made borrowing cheaper, making big purchases more attractive. These factors and many others are driving up costs.
The 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.
How is inflation measured?
There are different ways of measuring inflation, even among government agencies. The shorthand version comes from the Labor Department’s consumer-price index, or CPI, which 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. This inflation reading is the Federal Reserve’s preferred measurement. The Commerce Department releases its PCE estimate monthly as part of its income and spending report.
Just how fast are prices rising?
The CPI is up 8.5% from a year ago, according to the Labor Department’s report for February. With food and energy removed from the picture—prices in those categories can be volatile—CPI is up at a slightly lower rate of 6.5%. The readings, however, show that price increases are widespread and well above policy makers’ targets for annual inflation, which hover around 2% on average. The Ukraine crisis has boosted oil prices, with U.S. gasoline costs hitting a record in early March, adding to already high inflation.
That pace is the fastest 12-month gain for core inflation in four decades, which means about half of the nation has never seen a similar stretch of price gains.
What goods or services are driving the increase in prices?
Prices are going up throughout the economy, but not uniformly. Used-car prices rose 35.3% in March from a year earlier. Food prices were up 8.8%, the sharpest rise since 1981. Restaurant prices rose by the most since the early 1980s. Grocery prices increased 10%, as year-over-year meat and egg prices continued to climb at double-digit rates.
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. Annual wage growth is running at its fastest pace in two decades, but inflation continues to outpace wages for most workers, eroding their spending power.
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 start easing this year, but remain elevated above prepandemic levels into 2023. As is often the case among economists, there is disagreement about the level where price increases will stabilize.
How does 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. But mortgage rates recently hit their highest level in more than three years, something that could eventually crimp housing demand.
How does inflation affect the stock market?
Entrenched inflation would lead to the Fed raising interest rates more, which in turn raises borrowing costs and crimps growth to tame price pressures—fueling market volatility as businesses, consumers and the Fed attempt to navigate uncertainties about the economy.