Inflation 101: Why Are Prices Rising?
We have heard for many months now that inflation is running wild. According to the Bureau of Labor Statistics, the rate of inflation between May 2021 and May 2022 was 8.6%, the largest 12-month increase since 1981.
While this figure helps validate the economic hardship many households are experiencing, it does little to explain the nuance of the current economic climate. In reality, there are many factors contributing to the current rise in prices. Thus, to understand inflation, we must understand some of the current economic conditions contributing to the rise.
Supply Chain Disruptions
Supply chain disruptions have been one of the biggest contributors to inflation since the early days of the pandemic. Many people have looked to resume their pre-pandemic lives, but supply chains are not equipped to handle pre-pandemic demand.
For example, consider the June 2022 report from the Institute for Supply Chain Management (ISM). The ISM states, “In the June Manufacturing ISM Report On Business(PMI), the Supplier Deliveries Index indicated slower deliveries for the 40th consecutive month.” The report also reports inventory shortages that come with slower deliveries.
This puts upward pressure on the prices of goods. Less supply of the goods people want and need coupled with increasing demand inevitably leads to higher prices.
A struggling global wheat supply is a prime example of how supply chains are struggling to keep up with rising demand. In fact, a recent report from the UN stated that there were just 10 weeks of global wheat supply left. This comes amid the Russian invasion of Ukraine, as Ukraine provides a significant percentage of the world’s high-grade wheat production. This strain in production is leading the high wheat prices.
We know that rising home prices have been an issue for quite a while, and the data reflects that. For example, a Pew Research report shows that home prices increased slowly from 2016 to 2019. However, prices started to climb rapidly in 2019, from $327,000 in the fourth quarter of that year to $408,000 in the fourth quarter of 2021.
“Housing costs have also driven inflation because building materials have become more expensive due to supply chain backups,” says Dr. John C. Edmunds, professor of finance and entrepreneurship at Babson College. Indeed, supply chain backups are another issue that overlaps here.
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Russia’s Invasion of Ukraine
The war in Ukraine has already had a big cost in terms of human lives; in the Ukrainian port city Mariupol alone, the death toll is at least 21,000. While casualties are easy to measure, there are economic consequences, too. In fact, the Russian invasion is a factor in several other items on this list.
For example, we know the invasion has contributed to rising fuel prices. “The Russian invasion of Ukraine reduced the supply of oil, refined products, and natural gas,” says KC Mathews, executive vice president & chief investment officer at UMB Bank. “Gasoline prices climbed due to the reduction of refining capacity,” Mathews says.
The invasion has also contributed to higher wheat prices. As mentioned earlier, Ukraine produces much of the world’s wheat supply — about a fifth of the world’s high-grade wheat and 7% of all wheat, according to various reports. But Russia is also a big wheat producer, Mathews says. “Russia and Ukraine are responsible for more than a quarter of the world’s wheat exports.” The conflict has led to a significantly reduced global supply of wheat, and, thus, higher prices.
Worker shortages have been a problem in the U.S. throughout the pandemic. According to the Chamber of Commerce, about 47 million workers quit their jobs in 2021. While the Chamber notes that hiring has outpaced quit rates since about November 2020, certain sectors of the economy have nevertheless struggled to maintain their workforces.
Notably, the Chamber says that the transportation, healthcare and social assistance, accommodation and food sectors have had the most job openings in recent months. However, it said some of these industries have had low rates of workers quitting. The food sector, meanwhile, has struggled to retain workers.
Other industries, such as durable goods manufacturing and professional and business services, have had quit rates above 3%. As industries struggle to retain workers, they are unable to provide the goods and services customers demand, pushing prices higher.
The Great Resignation that led to worker shortages also contributed to a rapid rise in wage growth. As companies struggled to find workers to fill vacant roles, they increased wages much more than in the past. For example, wages were up 4% for the 12-month period ending December 2021, according to the BLS. The report said that the increase for the 12 months ending December 2020 was 2.5%, indicating a noticeable increase in wage growth.
Higher wages mean more money to spend, which generally means people buy more — and spend they did. A 2021 report from Deloitte predicted an 8.1% increase in consumer spending compared to a 3.8% contraction in 2020.
Increased Money Supply
The money supply has increased, for a number of reasons. In addition to the high wages mentioned, there were stimulus checks in 2020 that left people with more money to spend.
In addition, the Fed kept interest rates near zero for more than a year, making it very cheap to borrow money. In particular, the interest rates financing for new homes and cars were much lower than they had been in the past.
All of this combined is a driving force of the high rate of inflation we are currently experiencing.
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