New York City — Inflation in the US is showing signs of entering a more stubborn phase that will likely require tough action by the Federal Reserve, a shift that has panicked financial markets and raised the risks of a recession.
Some of the old drivers of high inflation—rising gas prices, the hustle of supply chains, and soaring used-car prices—are fading. However, basic measures of inflation are actually getting worse.
The continuing development of the forces behind the inflation rate, which is approaching its highest level in four decades, has made it difficult for the Federal Reserve to wrestle it under control. Prices are no longer rising due to higher prices for some categories. Instead, inflation has now spread more widely throughout the economy, buoyed by a strong labor market that boosts paychecks, forcing companies to raise prices to cover higher labor costs and give more consumers the cash to spend.
On Tuesday, the government said inflation rose 0.1% from July to August and 8.3% from a year ago, down from a four-decade high in June of 9.1%.
But excluding the volatile categories of food and energy, so-called core prices jumped an unexpectedly sharp 0.6% from July to August, after a smaller 0.3% rise the previous month. The Fed is watching core prices closely, and the latest numbers have heightened fears of a more aggressive Fed and sent stocks crashing, with the Dow Jones crashing more than 1,200 points.
The core price figures reinforced fears that inflation is now spreading to all corners of the economy.
“One of the most remarkable things is how broad the price gains are,” said Matthew Luzzetti, chief US economist at Deutsche Bank. “The underlying trend of inflation has certainly not shown any progress toward appeasing yet. That should be a concern for the Fed as price gains are becoming increasingly demand-driven and therefore likely to be more steady.”
Demand-driven inflation is one way of saying that consumers, who account for roughly 70% of economic growth, keep spending, even if they are upset about having to pay more. This is partly due to widespread income gains and partly because many Americans still have more savings than they did before the pandemic, after putting off spending on vacations, entertainment and restaurants.
When inflation is primarily driven by demand, it can require tougher action from the Federal Reserve than when it is primarily driven by supply shocks, such as oil supply disruptions, which often can resolve on their own.
Economists fear that the only way for the Fed to slow strong consumer demand is to raise interest rates too high in order to sharply increase unemployment and possibly cause a recession. Usually, as the fear of layoffs grows, the unemployed don’t just cut back on spending. So do many people who fear losing their jobs.
Some economists now believe the Fed will have to raise the benchmark short-term rate much higher, to 4.5% or higher, by early next year, more than its previous estimate of 4%. (The Fed’s main interest rate is now in the 2.25% to 2.5% range.) Higher rates from the Federal Reserve would, in turn, drive up the costs of mortgages, auto loans, and business loans.
The Federal Reserve is widely expected to raise its benchmark short-term interest rate by three quarters of a significant point next week for the third time in a row. Even Tuesday’s inflation report led some analysts to speculate that the central bank could announce a full percentage point increase. If that happens, it would be the biggest increase since the Fed began using short-term interest rates in the early 1990s to guide consumer and business borrowing.
Although headline inflation barely rose last month, core inflation, which reflects broader economic trends, worsened. The measure that the Cleveland Fed uses to track average inflation, which mainly ignores categories with the largest price swings, rose 0.7% in August. This was the largest monthly increase since records began in 1983.
High prices have not yet caused much of what economists call “demand destruction” – a slump in spending that could dampen inflation. Although higher gas prices have reduced the number of cars Americans drive, there is little evidence of significant reductions elsewhere.
Restaurant prices, for example, jumped 0.9% in August and are up 8% last year. But that didn’t noticeably discourage people from going out. Restaurant visits have surpassed pre-pandemic levels on Open Table, an app that tracks reservations, and were still increasing through September.
In general, consumers have largely kept their spending, even with rampant inflation, although it may have been through frayed teeth. In July, spending rose 0.2% after adjusting for higher prices.
The prevalence of inflation in services, such as rent and health care costs, largely reflects the effect of higher wages. Hospitals and doctors’ offices have to pay more for nurses and other staff. As more Americans find jobs or get bonuses, they are able to move out of family homes or separate from their roommates. Rental costs increased 6.7% last year, the most since 1986.
Wages and salaries jumped 6.7% in August from a year earlier, according to the Atlanta Federal Reserve’s payroll tracker, the largest increase in nearly 40 years. Luzzetti noted that the same data shows a standard pay premium for people who change jobs, compared to those who stay in their jobs. This means that employers are still offering big raises to try and fill positions.
Economists had hoped that higher prices for services would be offset by lower costs for goods such as new and used cars, furniture and clothing, after these items had risen in the pandemic. With improved supply chain support operations, a better influx of these goods was expected to drive down prices.
But this has not happened yet.
“We’ve seen shipping costs come down, we’ve seen supply chain congestion ease a bit, production improve and inventories rise,” said Laura Rosner Warburton, chief economist at MacroPolicy Perspectives. “All of this points to some improvement on the supply side. However, companies are still charging huge price increases for these goods, and that’s a problem.”
Such trends can renew the debate about the extent to which companies can raise prices fueled by a lack of competition, a phenomenon referred to as “greedy inflation.” But most economists attribute firms’ ability to pay more fees to consumers’ willingness to pay.
“Retailers seem to be raising prices now because they can, not because they have to. Consumer demand remains very strong,” Anita Markowska, chief economist at Jefferies, an investment bank, said in a research note.
Copyright © 2022 by The Associated Press. All rights reserved.
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