Is High Inflation Here To Stay?

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Ryan Abbott started planning months ago for a trip to Walt Disney World this summer.

Using credit card points and funds from the latest round of stimulus payments, the 31-year-old elementary school aide and his wife booked the trip knowing that, even with the extra financial help, their budget would be tight. To cut costs, they planned to bring groceries to save on food, and committed to driving the 1,000 miles from New Jersey to Florida instead of flying.

Then the price of gas jumped—up more than 22% just in the first four months of the year and now averaging more than $3 a gallon nationally—making that choice slightly less economical.

“If I had known gas would be going up like this,” Abbott said, “I would have given the trip a second thought.”

Key Takeaways

  • Consumer prices have skyrocketed this spring, and our expectations about high inflation can affect how long it sticks around.
  • The Federal Reserve believes the surge in prices will ease as the economy continues to reopen, but nobody knows for sure.
  • Factors like how fast we spend the money we’ve saved during the pandemic, and whether businesses can catch up with demand for their products, also figure into the equation.
  • Over time, inflation could be locked in by a “wage-price” loop, where workers anticipating higher costs ask for higher wages, and businesses factor those new expenses into their prices, creating a need for even higher wages to keep up.

Abbott’s concern about price inflation, which eats into consumers’ purchasing power by making the things we buy more expensive, seems warranted based on recent headlines. Consumer prices have soared this spring, and, oddly, what people like Abbott think about those high prices could actually determine how long they stick around. If enough people expect higher inflation and change their behaviors—like asking for a raise so you can afford that long-anticipated trip—prices might stay elevated a bit longer than they otherwise would have.

The price jumps have been notable, to be sure. Consumer Price Index (CPI) data for April shocked economists by showing an increase of 0.8% last month, four times as much as they expected. Even more jaw-dropping, the core index—which excludes prices for food and energy that tend to fluctuate—rose 0.9% in April, the largest month-to-month jump since April 1982.

The increase pushed the year-over-year core inflation rate to 3.0%, up sharply from 1.6% in March. That’s above the Federal Reserve’s traditional target of 2% (its goal for an average over time,) but still very little compared to the all-time inflation highs seen in 1980, when core CPI peaked at 13.6%.

Even so, the 3-month annualized rate—which takes the last three monthly increases to give a clearer picture of what’s happening right now—is currently a whopping 7.2%. And that number will likely move higher in the coming months, said Sarah House, senior economist at Wells Fargo.

While some of the year-over-year rise can be blamed on so-called base effects, where a decrease in inflation last spring means the baseline for year-over-year comparison now is low, month-to-month increases aren’t influenced by such effects. The Federal Reserve has acknowledged that prices are going up, but it says the spike should be temporary, due to what it calls “transitory factors,” like a surge in consumer demand fueled by government aid.

That surge can’t last forever, the Fed says, and it would prefer to be patient before raising interest rates to fight inflation. Acting too soon could stamp out the economy’s momentum completely, giving the Fed a very different problem to combat.

So, we’re stuck with high inflation for now. When—and how much—this inflation actually will fade depends on several things, like how long a current shortage of materials that’s causing a crunch in the supply of things to buy will last. But the most important factor could be the expectations of everyday people. 

Supply Chain Problems

If all this sounds scary, remember that a lot of today’s inflation isn’t likely to linger for too long. Here’s why:

Three rounds of stimulus payments and financial uncertainty due to the pandemic have caused households to save at record rates during the last year. Consumers in the U.S. have saved, in total, $2 trillion more than usual during the pandemic, according to an analysis by BMO Economics.

With the economy starting to reopen in recent months, people have begun to break open their piggy banks, and some of that money has started to flow into the economy. The U.S. economy grew 6.4% in the first quarter, largely because of regular people buying stuff. The sheer magnitude of consumer spending so far this year has been enough to push prices up, causing some inflation and catching businesses, which had downsized in an attempt to fortify themselves against pandemic conditions, off guard. 

It takes time for businesses to gear back up, and a shortage of material supplies and workers has prevented them from smoothly adjusting to the sudden surge in demand. There are no quick fixes to the supply issue, House said, and we’ll continue to see it throughout 2021. Eventually, though, the supply chain will catch up, and some of that pent-up demand will ease.

While all that plays out, though, what really will be critical is how people view inflation and how their expectations influence their behavior, House said. If people believe higher inflation is here to stay, it could become a self-fulfilling prophecy. 

Less Confidence in the Economy

Workers anticipating a higher cost of living usually require higher wages, and businesses are likely to pass on any new expenses, like increased labor costs, in their prices. Higher prices require higher wages for workers to keep up, creating a loop that essentially locks in inflation.

Some companies, with plenty of open jobs but few takers, already have hiked their wages to attract more workers as the pandemic winds down. McDonald’s plans to raise wages for entry-level positions to between $11 and $17, the fast food giant announced last week, and is offering a $1,000 bonus to workers who accept positions at some locations. Chipotle announced a similar plan last week. Bank of America said Tuesday it has begun lifting the minimum wage it pays, with the goal of paying no less than $25 per hour by 2025.

Consumers, meanwhile, have noticed higher prices, and now say they have less confidence in the economy’s strength because of high inflation, according to the results of a University of Michigan survey released Friday.

Rising wages could worsen this inflation, House said. But the pandemic has also created a unique circumstance: There’s a lot of uncertainty at the moment about what exactly is going on in the economy, including with inflation. Things like the cost of renting a home—which makes up a large chunk of CPI but lags behind other items, since the cost of rent usually changes only once a year—could complicate matters further.

The picture will become clearer as we move a few months away from the economy’s initial reopening. And it’s important to remember that a one-month jump in prices doesn’t necessarily mean that inflation has set in, House warned.

“Inflation is a process,” she said.

In other words, while we’re apt to see price increases for a few more months, only time will tell whether we’ll be living with higher inflation for a while.