Rising Costs and Inflation

Rising Costs and Inflation

COVID-19 came as a shock to Americans who spent much of 2020 at home. Now that COVID-19 restrictions are easing up and people are getting out more, Americans are feeling a shock of a different kind: Sticker shock.

The prices of food, clothing, gasoline, used cars, and other products have skyrocketed now that the U.S. economy is rebounding from the COVID-19 pandemic. But, what is putting a sizable dent in the wallets of consumers? Economists point to inflation.

Inflation is the steady rise in the overall prices of consumer goods and services. Inflation has several causes but two of the most common types of inflation are “cost-push” and “demand-pull.”

Cost-push inflation occurs when overall prices rise because of a “push” or increase in wages, raw materials, and other production-related factors. In this type of inflation, consumers’ demand for goods and services remains consistent despite increases in cost. For instance, higher production costs or labor shortages may push up gas prices. Consumers, however, will buy gasoline for their vehicles even if there is a significant jump in gasoline prices.

Demand-pull inflation occurs when consumers’ demand for goods and services increases and producers cannot meet the demand. An example of this was in April when the U.S. Bureau of Labor Statistics (BLS) released its monthly inflation report. The BLS noted that prices increased 4.2 percent from April 2020, primarily because of price increases in hotel and airline fares.

Consumers were not able to travel in 2020 because of COVID-19. So, thanks in part to new COVID-19 vaccines, consumers felt more confident to travel during spring break. Hotels and airlines, working with fewer employees (because of pandemic-related layoffs), and facing higher operating costs (such as an increase in jet fuel costs), raised their prices.

Pandemic Interrupts Global Supply Chain

Companies also cannot keep up with consumers’ demands because of a disruption in the global supply chain due to the COVID-19 pandemic, according to economists.

The impact the pandemic has had on global supply chains is “a major disruption, along the lines of having an earthquake or a tsunami,” said Morris Cohen, a professor of operations, information and decisions at the Wharton School of the University of Pennsylvania. “This is an unprecedented type of disruption. I don’t think we’ve ever seen anything quite like this.”

The auto industry has been experiencing this supply-chain disruption. While consumers want new cars, a global computer chip shortage has prevented automobile manufacturers from manufacturing new vehicles. Despite low inventories of new vehicles, however, GM saw a 40-percent increase in new cars sales in the second quarter, compared to a year ago.

“The U.S. economy is accelerating, consumer spending is robust and jobs are plentiful,” Elaine Buckberg, GM chief economist said in a news release about the increase in car sales. “Consumer demand for vehicles is also strong, but constrained by very tight inventories. We expect continued high demand in the second half of this year and into 2022.”

Inflation also affects consumers’ “purchasing power,” which is how much consumers can buy with a given amount of money. A rise in inflation means consumers are buying less with their money.

Measuring Inflation

There are several ways to measure inflation, but the most common way the government gauges inflation is through the Consumer Price Index for All Urban Consumers (CPI).

The CPI measures the average price changes in goods and services that people living in urban areas consistently buy for their households, such as food, clothing, and automobiles.

The CPI has been climbing all year long, according to the BLS, which maintains the CPI index. BLS figures show the CPI rose 5.4 percent in the 12 months ending June, its largest gain since August 2008.

The indexes for food, airline fares, and apparel all had sharp increases in June, with used cars and trucks accounting for more than one-third of the CPI increase. The vehicle prices increased 10.5 percent, the largest jump since January 1953 when the used cars and trucks index was first reported.

BLS Report: Consumers Paying More For Food

Food that consumers bought to eat at home increased 1.4 percent in June, compared to the same time last year, while “food-away-from-home” prices have increased 2.5 percent, according to the BLS report for June.

The U.S. Department of Agriculture (USDA) also tracks food prices. Of all the CPI categories tracked by the USDA, fresh fruits, such as oranges, lemons, and grapefruits, had the largest increase in June of 4.8 percent.

Natural disasters also had a hand in driving up food costs. For example, the record-breaking winter storm in Texas in February caused a shortage in chickens and other livestock. As a result, chicken wings are now averaging $3.64 a pound, up from $2.80 a year ago, according to the USDA’s national retail report for the week of July 16. Winter storms—as well as drought—also disrupted the beef supply.

Additionally, higher prices for sows (adult female swine) and increased production costs have affected the pork industry. Of all the pork products, bacon is usually more costly to produce because curing and smoking pork belly is a lengthy process. This is one of the reasons why the average price of a pound of sliced bacon was $5.71 the week of July 16, compared to $4.89 the same week in 2020, according to the USDA’s report.

Inflation Expected To Continue in 2021

The recent increase in consumer prices “should be celebrated” since this means inflation is getting back on target, says Claudio Borio, head of the economic and monetary department at the Bank for International Settlements, in Basel, Switzerland. Borio expects what is going on now is temporary.

Policymakers at the Federal Reserve, which determines the United States’ monetary policy, agree with the view that the rise in prices is temporary and do not plan to change policy.

Federal Reserve Chair Jerome Powell told a congressional panel in June that there are no plans to raise interest rates based on fears over inflation.

If this is the case, it’s important for the Federal Reserve to make sure that this is seen as a temporary blip and not systemic, says John Horn, professor of practice in economics at Olin Business School at Washington University in St. Louis.

“If it’s seen as a systemic problem, and inflation expectations take charge, it’s really hard to make it stop,” Horn says. “Once that happens, the only way to stop inflation is to raise the interest rates really high and cause a recession. Maybe not in 2022, but it will be on the Fed’s radar. They will want to stop [rising inflation] sooner than later.”

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