Here’s what you need to know about America’s blisteringly hot inflation

The government reported on Friday that consumer prices rose 8.6 percent for the year to May, the fastest rate of increase in four decades.

Americans face higher prices for food, fuel and housing, and some are looking for answers about what’s causing the price hike, how long it could last and what can be done to solve it.

There are few easy answers or painless solutions when it comes to inflation, which has skyrocketed around the world as tight supply collides with hot consumer demand. It’s hard to predict how long today’s price hike will drag on and the key tool to combat it is rate hikes, which cool inflation by slowing the economy – potentially sharply.

Here’s a guide to understanding what happens to inflation and how to think about gains as you navigate this complicated moment in the US and world economy.

It may be helpful to think of the causes of today’s inflation as falling into three related categories.

  • Strong demand. Consumers spend a lot. At the start of the pandemic, households were piling up savings as they were stuck at home, and government support, which lasted until 2021, helped them put even more money aside. Now people are taking jobs and getting pay increases. All of these factors have bolstered household bank accounts, allowing families to spend on everything from backyard barbecues and beach vacations to cars and kitchen tables.

  • Too few goods. As families took pandemic savings and tried to buy pickup trucks and computer screens, they ran into a problem: there weren’t enough goods to get around. Pandemic-related factory closures, global backorders and reduced production have resulted in shortages of parts and products. As demand exceeds the supply of goods, businesses have been able to charge more without losing customers.

    Now China’s recent lockdowns are exacerbating supply chain problems. At the same time, the war in Ukraine is restricting global food and fuel supplies, driving up headline inflation and adding to the cost of other products and services. Gas prices are averaging about $5 a gallon nationwide, up from just over $3 a year ago.

  • pressure in the service sector. More recently People have shifted their spending away from things and back to experiences as they adjust to life with the coronavirus – and inflation is simmering in the services industry. Rents are rising rapidly as Americans compete for a limited supply of housing, restaurant bills soar as food and labor costs soar, and airline tickets and hotel rooms become more expensive as people travel and as fuel and labor are more expensive.

You may be wondering: What role does corporate greed play in all of this? It is true that companies make unusually large profits by raising prices more than is needed to cover rising costs. But they can in part because demand is so strong — consumers are spending directly through price increases. It’s unclear how long this pricing power will last. Some companies, like Target, have already signaled they will start slashing prices on some products as they try to clear inventory and attract customers.

Economists and policymakers are closely watching America’s two primary indicators of inflation: the consumer price index, which was released on Friday, and the personal consumption spending index.

The CPI tracks how much consumers are paying for things they buy, and it comes out earlier, making it the nation’s first clear look at what inflation did the month before. Data from the index is also used to determine PCE numbers.

The PCE index, which will be released next on June 30th, tracks how much things actually cost. For example, it counts the price of health care procedures, even if the state and insurance pay for them. It tends to be less volatile, and it’s the index the Federal Reserve relies on when attempting to achieve average inflation of 2 percent over time. As of April, the PCE index rose 6.3 percent year-on-year – more than triple the central bank’s target.

Fed officials closely monitor changes in monthly inflation to get a feel for their dynamics.

Policymakers are also particularly attuned to the so-called core inflation measure, which excludes food and fuel prices. While food and gas make up a large portion of household budgets, they too are jumping in price in response to changes in global supply. As a result, they don’t give as clear a view of the underlying inflationary pressures in the economy – those that the Fed believes it can do something about.

“I’m waiting for a steady string of slowing monthly core inflation numbers before I’m more confident that we’re getting to the kind of inflation curve that will take us back to our 2 percent target,” said Lael Brainard, the Fed’s vice chairman and one of her key public messengers, during a CNBC interview last week.

How long prices will continue to soar is unclear: Inflation has puzzled experts repeatedly since the pandemic took hold in 2020. But based on the drivers behind today’s hot prices, some outcomes look likely.

For one thing, rapid inflation seems unlikely to go away on its own. Wages are rising much faster than normal. This means that unless companies suddenly become more efficient, they will likely try to keep raising prices to cover their labor costs.

As a result, the Fed is raising interest rates to curb demand and curb wage and price growth. The central bank’s policy response means the economy is almost certainly headed for a slowdown. Higher borrowing costs have already started to cool the housing market.

The question – and great uncertainty – is how much Fed action will be required to bring inflation under control. If America is lucky and supply chain bottlenecks ease, the Fed may be able to moderate the economy and slow the job market enough to dampen wage growth without triggering a recession.

In this bullish scenario, often referred to as a soft landing, companies will be forced to lower their prices and curb their big profits as supply and demand rebalance and they compete for customers again.

But it’s also possible that supply problems remain, leaving the Fed with a more difficult task: raising interest rates more sharply to sufficiently dampen demand and contain inflation.

“The road to a soft landing is very narrow — narrow to the point where we expect the baseline to be a recession,” said Matthew Luzzetti, chief US economist at Deutsche Bank. That’s partly because consumer spending has shown little sign of slowing down so far.

Households still have about $2.3 trillion in excess savings to help them weather higher interest rates and prices, Mr. Luzzetti’s team has estimated.

“There continues to be a lot of catching up to do,” Anthony G. Capuano, chief executive of hotel company Marriott International, said during a June 7 event. “Unlike previous economic cycles and economic downturns, here you have this extra dimension where people have been locked in for 12 to 24 months.”

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