Inflation is rising. The most recent CPI inflation report, like in the Spring, revealed that prices rose across the board in July. By a long shot.
According to the Bureau of Labor Statistics (BLS), prices increased 5.4% year on year in July and 0.9% month on month. Last month, the indices for housing, food, energy, and new autos were major drivers of inflation rise.
Those products, of course, are essential to the basic financial lives of many Americans, hence stretching their bottom line.
Even when volatile food and energy prices are excluded (so-called core CPI inflation), prices grew 4.3% year on year, or approximately 2 percentage points higher than before the pandemic.
Certain factors contributed significantly to these unprecedented improvements, as anyone who has just purchased a car may attest.
In July, new vehicles and trucks were 1.7% more expensive than in June, continuing an expensive trend. Energy costs increased by 1.8%, with gas prices increasing by 2.4%, just in time for the summer vacation season.
The Federal Reserve, whose mission is to keep price growth moderate, has been warning anybody who will listen that more inflation is on the way as the economy returns to normalcy.
The Fed also claims that short-term inflationary pressures will give way to more sustainable price growth in the long run.
Nonetheless, the July CPI figures, when paired with those from previous months, will put that perspective to the test. Saying that higher prices are temporary and that inflation was too low prior to the pandemic is easier than actually living with the increase, especially because July salaries increased by only 4.0% from the previous year.
But what is behind these price increases, and what does it all imply for you?
Let’s take a look at airfares to get a sense of what’s going on.
When the Covid-19 pandemic broke out last spring, demand for travel fell. People canceled tickets in droves, postponed vacations, and hunkered down as stay-at-home orders went into effect.
As a result, flight rates fell significantly.
For example, in April 2020, airfares plummeted 24% year on year, and they would remain low for the remainder of the year. When comparing airline ticket prices during Covid-19 to prices before to Covid-19, they were typically around 25% less expensive.
However, after a year, these year-over-year comparisons changed: the June CPI data, for example, compared vaccine-era airline fares to those after Covid-19 struck.
So it’s not unexpected that airline fares in June 2021 were about 25% higher than a year earlier, if only because there were so few individuals buying tickets at the time.
This is one of the important issues that the Fed has been emphasizing: you must pay attention to what are known as base effects. More people will fly now that vaccinations are widely available and Covid-19 cases are decreasing.
Yes, airline prices are substantially higher than they were a year ago, but they are still lower than they were prior to the pandemic.
Nonetheless, these fundamental impacts do not account for everything.
Consider used automobiles and trucks: While prices fell prior to the recession, used cars and trucks did not become less expensive than they were in February 2020. In fact, they’ve never been more expensive than they are now.
To be clear, the reasons for that increase are related to the pandemic.
Supply is constrained as a result of new car production being stalled by an ongoing chip shortage, individuals holding onto their leases for longer, and rental car companies, a key source of second-hand cars, having fewer to unload after restricting their inventory when the pandemic began.
The Fed has also warned the public about these and other supply-chain difficulties, stating that it would take time for certain sectors of the economy to return to normal.
The Fed believes that once these issues are ironed out, inflation will slow down.
That is cold comfort for families looking for a used automobile, and customers will need to be careful with how they divide their budget in the coming months.
Strange pricing swings, on the other hand, were an unavoidable side effect of shutting down the economy to combat the infection, so they shouldn’t come as a surprise.
Fortunately, they are expected to be temporary, but they may endure while the Fed strives to bring people back to work, according to Nancy Davis, founder of Quadratic Capital Management.
The Federal Reserve is more focused on the employment aspect of its dual mandate and will stay accommodative for as long as necessary to guarantee the economy recovers to full employment.
In summary, the Fed’s low-interest rates and bond purchases, called “easy money” to stimulate economic activity, are unlikely to change for the time being, and businesses (and their stocks) may continue to rise.
This type of assistance is likely to be required, given the April and May job reports disappointed many.
Employers added more jobs in June, but the unemployment rate remained significantly above pre-pandemic levels, and many millions remain unemployed. Fed Chair Jerome Powell has stated repeatedly that he is committed to returning to full employment and will not be influenced by temporary increases in inflation.
In reality, the Fed said last August that it would tolerate greater inflation than its goal rate for a limited time because inflation has been too low for the previous 10 to 15 years.
However, the Fed does not expect rising inflation to last after more people return to work.
Powell recognized that inflation had risen in recent months in testimony to Congress at the end of June, blaming it on base effects, higher oil costs, people reopening their wallets, and supply chain difficulties.
“As these temporary supply effects fade, we expect inflation to return to our longer-run target,” Powell added.
Market observers are now wondering how temporary this inflationary increase is and how long normal Americans can bear it.