Key Takeaways
- Inflation has exceeded 7.5% this year, though it has started to slow in recent months.
- Many factors, from supply chain issues to war in Ukraine, have contributed to high inflation.
- The Federal Reserve sees fighting inflation as essential and has increased interest rates, despite the risk of triggering a recession.
One of the biggest economic stories of 2022 has been high inflation, everything from fuel to food to entertainment has gotten more expensive over the past year, and the Federal Reserve has taken steps to try to curb it. At the same time, wage growth hasn’t kept pace, leaving many feeling the pinch as they’re unable to buy the same things they could a year ago.
Economists and citizens alike wonder whether inflation is here to stay and worry about the lengths the Federal Reserve will go to in its fight against inflation.
What is inflation?
Inflation is a process through which money loses purchasing power over time. Put another way, over time, prices for goods and services tend to rise.
Economists generally agree that a relatively low, steady rate of inflation is healthy for an economy. It helps encourage borrowing and spending. However, deflation or high inflation are negative for the economy. The Federal Reserve has a target inflation rate of 2% per year, though many economists believe this figure is going to be higher moving forward, some say we are more like to settle in at 4-5% inflation for some time.
Inflation history
Inflation has been highly volatile over the past century. In the United States, the Bureau of Labor Statistics calculates inflation using the Consumer Price Index (CPI), which is calculated based on the cost of a variety of goods, like food, transportation, fuel, clothing, and more.
Prior to World War II, inflation was highly volatile. For example, 1920 saw prices rise by more than 15%, while the next year saw a drop of more than 10%. Things smoothed out around 1950 and the following two decades saw inflation hover between 0% and 5%, but usually sitting around 2%.
Inflation spiked in the mid-1970s and remained high through about 1984. The period of 1979-1981 saw price increases of 11.3%, 13.5%, and 10.3% respectively, significantly slashing the purchasing power of the dollar.
The three decades prior to the onset of the COVID-19 pandemic saw much more controlled inflation, with 5.4% in the 1990s being the highest rate, and the typical inflation being close to the Fed’s target of 2%.
As the pandemic receded, however, inflation began to rise.
How much have prices risen and why?
COVID-19 hit the world in early 2020, upending the economy with global lockdowns and a variety of global supply chain problems. Even as the pandemic recedes, its impacts are easily noticeable in the supply chain issues that many businesses face and the changes in employment across the country.
Inflation began to spike in the U.S. in April of 2021, when it hit 4.2%. Inflation continued to climb, hitting 7% year-over-year by December 2021.
Sadly, 2022 didn’t see any slowdown in inflation as the rate peaked at 9.1% in June. Starting in July, inflation began to fall slightly, though it still sat at 7.7% in November.
There are many reasons that prices increased as the pandemic ended.
Transitory inflation
Initially, many believed that high inflation rates were transitory. Inflation had plummeted in 2020 as COVID-19 shuttered the economy, so it made sense that prices would rise quickly after the pandemic.
Supply chain issues, plus significant increases in just a few segments of the economy, such as used cars, exacerbated the issue. The Federal Reserve expected prices to return to normal in a relatively short time, but that wasn’t the case.
Long-term supply chain problems
Another contributor to inflation is the global supply chain crisis. COVID-19 forced many economies to close down, which caused shipments of many goods to stop almost completely. It takes a long time to restart the global supply chain from a dead stop, and shipping prices have grown significantly.
Fuel prices have also increased, contributing to higher transportation costs.
OPEC supply cuts
OPEC, the group responsible for a huge percentage of the world’s oil production, recently announced that it would cut production by 2 million barrels per day. This cut is the largest cut since the beginning of the COVID-19 pandemic.
OPEC claims that it is trying to avoid price volatility in the event of a recession, but its actions have exacerbated fuel price increases.
Russia’s invasion of Ukraine
Russia invaded Ukraine in February 2022, which many analysts believe has contributed to inflation.
Russia controls a large supply of oil, particularly in Europe. Ukraine is responsible for exporting food throughout the world. Given that they are in the middle of a war, exports are difficult and Russia has cut its exports to try to pressure countries into limiting the amount of assistance they provide to Ukraine.
Reductions in Russian oil exports and Ukrainian food exports have led to shortages and price hikes.
Corporate price increases
Many analysts and politicians fear that companies are using high inflation as an excuse to increase prices and capture higher profits. These price increases also contribute to inflation, making inflation something of a self-fulfilling prophecy.
A New York Times report found that more than 2,000 companies experienced profit margin increases well above pre-pandemic averages, which is an argument in favor of this theory.
Monetary policy
The Federal Reserve’s mandate includes maintaining high levels of employment and a reasonable rate of inflation. Given that inflation has surged past the Fed’s target of 2%, it has had to take steps to fight inflation.
Until very recently, the Fed had kept its benchmark interest rate, the federal funds rate, near 0%. This encouraged people to borrow and spend far more than it encouraged people to save, which can also contribute to inflation.
The Fed has boosted its benchmark rates to try to curb price increases, but many argue that loose monetary policy since the 2008 Great Recession has contributed to the current inflation rate.
Looking forward
The economy is complex and has a lot of moving parts to it. Many experts fear that inflation will continue for the next year or two.
The Federal Reserve seems committed to fighting inflation by raising rates, even if it could lead to a recession. Federal Reserve chairman Jerome Powell has admitted that a “soft landing” is becoming less likely, stating that “No one knows whether this process will lead to a recession or, if so, how significant that recession would be. We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t.”
Final Word
Many Americans have felt the pinch of higher inflation rates, and uncertainty about how the economy will respond to inflation has led to market volatility. That can make investing difficult.
If you’re looking for investing help in this very volatile market, consider working with Q.ai, our artificial intelligence scours the markets for the best investments for all manner of risk tolerances and economic situations. With Q.ai’s Investment Kits, investing is straightforward and highly strategic, even in an inflationary environment like we have now. As such, the Inflation Kit is a smart entry point for many investors.
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