Why everything is so expensive – Grid News

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Why everything is so expensive

Inflation is just a number.

It is a number that is at a multidecade high. The consumer price index rose 7 percent in the last year. But this one number — one number worrying enough to cause the Federal Reserve to plan to hike interest rates over the next year in order to let some steam out of the economy — is a composite of an economy in an unprecedented flux as it still struggles with covid-19 and how governments, businesses and individuals respond to it.

While each item of the index — cars, homes, energy and so on — tells its own story, there is an overall picture: The economy is recovering far, far quicker than it typically does following a severe recession, but the growth is unbalanced, showing up in some places in high prices.

There’s more comfort in that number than the initial headlines lead you to believe.

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Inflation is just one piece of the overall puzzle. What really worries economists is not just inflation per se, but a situation, as in the 1970s, where prices are rising and the economy is otherwise stagnant, with little job growth or overall growth. This condition is called, naturally enough, “stagflation.”

There’s clear evidence that stagflation is not the direction in which the economy is headed. The unemployment rate is down to 3.9 percent, and overall output is easily above its pre-covid level. This is not quite down to that 3.5 percent unemployment rate, but it’s simply not the situation that the labor market is trending in the wrong direction.

While there are about 4 million fewer working than before the pandemic, the measure of the portion of so-called prime-age people in the labor force — those between 25 and 54 — is at 81.8 percent, compared with 83 percent before the pandemic. This suggests that much of the dropout of workforce participation is happening among retirement-aged people, who may rightfully not want to work right now and could come back to the labor force as it strengthens.

Some sectors remain depressed: The hospitality sector has just over 1 million fewer workers, while there are about 400,000 fewer employed in the nursing and residential care industry, and the retail sector has shrunk from 15.6 million workers to 15.4 million. But others have come close to their February 2020 level or even grown: The warehousing and storage sector had 1.3 million workers before the pandemic exploded in the U.S. and now has 1.5 million workers.

So here we have a basic picture of the economy: People’s ability to buy stuff has been bolstered by government assistance and the continued functioning of the goods-producing industry while the service sector has been hit by several factors, including consumers unwilling or unable to, say, go on a trip or go to a restaurant, as well as workers being unable or unwilling to return to jobs lost during the early months of covid.

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This has resulted in a general increase in wages. Workers have become scarcer and are more willing to leave their jobs. While the Federal Reserve does not yet point to rising wages being responsible for higher prices, Federal Reserve Chair Jerome Powell did warn that it could be a possibility. While there are several measures of wages — including measures showing that many workers’ “real” wages have declined thanks to increases in the cost of living — one measure, the Employment Cost Index, started rising faster in the second half of 2020.

But overall, inflation has been driven by the idiosyncratic economics dynamics of the pandemic.

The major culprit throughout the pandemic has been cars, especially used cars. Early in the pandemic, Americans largely stopped moving around, and car manufacturers slashed their orders of key electronic components, namely semiconductors. But Americans actually wanted to drive as much, if not more, than before. Demand for cars — new cars, used cars, rental cars — shot up exactly when manufacturers couldn’t meet the demand by building enough new cars, used car lots were picked over and rental car companies had liquidated much of their fleets. The result has been massive inflation, especially in used cars. Some of this has been for “bad” reasons — when fewer new cars are produced, the whole market tightens up — but it’s also been for “good” reasons: Thanks for government support in the form of unemployment insurance, direct payments and aid to businesses to keep up payrolls, there was a decline in repossessions. The result: higher and higher prices.

But you don’t just spend money on cars, and neither does the American consumer. They also spend a lot of money on gas — and gas, along with energy consumption writ large, has been a major contributor to the inflationary boom.

After bottoming out during the shutdown period of the pandemic, gas prices quickly rose. While gas and energy prices fell slightly in December, likely thanks to the omicron variant slowing down the economy, they’re still up substantially over the past year.

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Some of this was just the return of demand as the economy recovered (gas prices returned 2014 levels), but some of this is also due to structural changes in the U.S. oil and energy markets. Namely, U.S. energy producers have gotten far more conservative, cutting down capacity in the mid-2010s, and energy production is not yet back to pre-covid levels. All the while, Americans are driving nearly as much as ever.

But what about the supply chain crisis? Yes, there have been large delays and difficulties getting some items, but the overall story with purchasing goods has been more mixed at the macro level. What happened is that over the course of the pandemic and subsequent economic fallout, Americans shifted their consumption from services to goods, especially durable goods — stuff that sticks around for a while (furniture, cars, stuff like that). While services still amount for the bulk of U.S. consumer spending, shifting the balance between goods and services can have large effects.

This is where the supply chain crunch comes in. There has been major stress in ports and throughout the transit and logistics system that moved goods around — any time a port is closed or slowed down because of a covid outbreak, the stress propagates throughout the system, slowing it down and clogging things up more. This has raised the costs of basically anything that needs to be shipped.

There’s also what’s known as the “bullwhip effect,” where businesses are hoarding the goods they need — making large orders knowing they’ll get them only partially filled — which then leads to more shortages and stress throughout the system. Inasmuch as these effects are what is driving inflation, then you’d expect to see similar increases in prices all over the world, which is happening.

The major question facing policymakers, businesses and everyday consumers who have to make decisions is how likely this increased inflation is to persist. If the inflation problem is largely being driven by how consumers and businesses have had to adjust to covid, then it could be severe but temporary.

But temporary could be a long time — as we know now, the public health situation is rarely settled.

  • Matthew Zeitlin
    Matthew Zeitlin

    Domestic Economics Reporter

    Matthew Zeitlin is an economics reporter at Grid focused on the domestic impact of major stories such as coronavirus, the supply chain and economic volatility.