If you’ve been noticing your trips to the grocery store cost suddenly cost a lot more, or that the price of gas is much higher than it was 1-2 years ago, you’re not alone. As of June 2022, inflation has skyrocketed to 9.1 percent, the highest it’s been since 1981. That’s well over the 7 percent experts had expected back in the summer of 2021 and overall, not good for U.S. consumers.
So, with the COVID pandemic not as severe as it was back in 2020 and unemployment at record low rates, what’s going on? In this post, we’ll talk about inflation, explain what it is, and go over some of the reasons why you’re seeing this strain on your finances.
What is Inflation Anyways?
When the news reports that inflation has risen, what they’re actually referring to is the year-over-year change in the CPI or consumer price index.
The Consumer Price Index
The CPI is a measurement of the average prices paid by urban consumers for a market basket of consumer goods and services. This would include everything from food to housing, energy, the price of automobiles, etc. CPI figures are collected, compiled, and reported monthly by the U.S. Bureau of Labor Statistics.
Under normal conditions, inflation rates are generally quite low. Naturally, as businesses and goods cost more over time, the CPI now compared to a year ago will be higher. However, in times when inflation gets out of control, the government will step in and try to curb the situation.
The Federal Reserve and Inflation
The U.S. Federal Reserve, or as it’s sometimes called “the Fed”, is tasked with regulating monetary policy. This is primarily done through how it lends money to banks. When inflation is high, the Fed will raise the federal rate which then causes banks to raise the rate they use (called the prime rate) to set their products such as loans, credit cards, etc.
The desired outcome is that as it becomes more expensive for consumers and businesses to function, demand will decline, and prices will stop increasing or possibly even reduce. However, the Fed must do this very carefully because if they raise interest rates too quickly, it can stifle the economy and cause it to go into a recession (or potentially worse).
What’s Causing High Inflation in 2022?
Unfortunately, it’s hard for anyone to definitively say what’s causing inflation until several years later when the experts can look back with accurate data and information. However, most economists will agree that the current situation in 2022 can most likely be traced back to a handful of probable causes.
Disruption from the COVID Pandemic
The COVID pandemic undoubtedly caused a massive shockwave in every industry that will likely continue for several years to come. From the very beginning when stores closed their doors and states went into lock-down mode, people everywhere simply stop buying and companies stopped producing.
After a while when society started operating like normal, there was a surge in demand but not enough supply to keep up. One example of this is the microchip shortage in the automotive industry. Manufacturers couldn’t produce and dealerships everywhere couldn’t get in the latest models. That caused consumers to buy up all the used cars driving up the price to practically that of a new vehicle.
In a desperate attempt to provide immediate relief to American citizens and businesses, the federal government passed three major stimulus packages in 2020 and 2021:
- The CARES Act
- The Coronavirus Relief Act
- The American Rescue Plan
The price tag for these bills was nearly $5 trillion. Millions of people across the U.S. were sent checks for several thousands of dollars. Businesses also had access to new assistance programs that weren’t previously available.
While everyone was very happy at the time to receive these funds, many experts fear “too much” was done too quickly. People and businesses had more money than ever to spend ever, and some believe it was poured gasoline on the fire for “demand” that was already there.
Federal Reserve Slashing Interest Rates
During any time of financial crisis, the Fed’s main go-to reaction will be to cut interest rates. In the years following the Great Recession in 2008, the Fed had slowly crept up interest rates from practically zero to as high as 2.38%. However, as an emergency response to the COVID crisis, the rates immediately went back down to zero again.
While slashing interest rates generally has desired overall effect of stimulating the economy, it can also lead to unintended consequences such as high inflation. Given how low-interest rates were in the decade between the Great Recession and the COVID pandemic, some experts argue that this was a breeding ground for delayed high inflation.
Quantitative Easing from the Previous Recession
One more suspect that doesn’t receive a lot of attention but could have equally been a driver of inflation is quantitative easing or QE. Once the Fed slashes interest rates to zero, its next play is to use QE where they will buy up long-term securities from the market, flush banks with more funds, and attempt to bring down their interest rates to further stimulate the economy.
QE was used during the Great Recession and is a relatively new strategy that had been used in Japan in the decade prior. The Fed decided to use QE to keep the housing market crash from turning into a full-blown depression.
However, even after the markets recovered, the Fed continued QE for six years before it finally scaled back its operations. Some economists argue that this gave the banks too much money while not doing enough to let the economy recover on its own, and the delayed consequence is the higher than average inflation we have today.
The War in Ukraine
Finally, let’s not forget about the war between Russia and Ukraine. Although the U.S. isn’t directly involved, the trade sanctions that have resulted are reducing the global supply of commodities like crude oil and petroleum products.
Will Inflation Ever Return to Normal?
Though the situation with the economy can seem pretty shaky at the moment, it’s important to remember that market cycles of good times and bad times are perfectly normal. Even though the Fed foresees interest rates staying above their 2 percent annual target into 2024, the steps they’re taking now to aggressively raise rates will eventually cause supply and demand to even out.
For now, the best thing consumers can do is to try to keep a close eye on their finances. Make a budget and keep track of it using a helpful app like Buxfer. Also, don’t make any rash moves with your investments and continue to contribute to your retirement plans. Just like in previous times of economic trouble, patience will prevail.
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