Just as COVID-19 circled the globe without a passport, the inflation surge that followed didn’t recognize international borders either. The U.S. was just one of many countries where prices rose at their fastest pace in decades.
Pandemic-related economic disruption was the catalyst, but there’s no one culprit to blame for today’s high inflation. It’s a complex issue that’s become even murkier because nearly all of the contributing factors — from stimulus payments to oil imports — are politically charged topics that make finger-pointing irresistible.
With that in mind, the following is a look at how we got here with inflation, and what it means for you and your wallet moving into the new year.
Three economic forces can trigger a quick rise in prices, and the global economy was hit with all of them simultaneously in the wake of the pandemic.
- Demand-pull inflation: Prices rise when demand for goods and services grows faster than the available supply can accommodate. When the virus waned and the world reopened, stimulus-flush consumers released a flood of pent-up demand into a global economy whose supply chains hadn’t yet recovered and couldn’t keep up.
- Cost-push inflation: When the price of raw materials rises, manufacturers pay more to make their products and pass those added expenses onto their buyers, who then pass them onto their customers. In 2021, wholesale prices rose by nearly 10%.
- Built-in inflation: As demand-pull and cost-push inflation reduce household buying power, workers seek higher wages to maintain their lifestyles. Businesses then raise their prices to keep up with increasing labor costs. In 2021, built-in inflation soared as stimulus-flush workers flexed their newly acquired leverage in what came to be known as the Great Resignation. Employers struggling to staff their operations were forced to raise wages to compete, and U.S. labor costs rose at their fastest pace in 20 years.
“The inflation of 2022 was caused by a convergence of factors,” said Collin Plume, a 20-year financial services industry veteran and CEO of Noble Gold Investments. “Supply chain jams, manufacturing shutdowns, labor shortages due to the COVID-19 pandemic, sanctions on Russia limiting oil imports, the U.S. government minting money for stimulus payments, and so on. Consumers felt the tightest squeeze on their wallets in decades, especially in essential areas of spending such as groceries, gas, housing, and cars.”
Rapid price increases hit low-income households the hardest because they are forced to spend more of their limited dollars on necessities that they can’t go without.
“Affluent households often own real estate and equities, which both tend to keep pace with inflation over time,” said Gary Zimmerman, a former investment banker and founder and CEO of MaxMyInterest. “By contrast, those living paycheck to paycheck might see a small bump in their take-home pay, but will face much higher costs for food, gasoline, rent and other staples. As a result, inflation can be viewed as a particularly acute problem for those with little or no savings, who may be forced to choose between eating dinner or putting gas in the car. Money is fungible, so one dollar more for gas means one dollar less available for food — or for saving.”
If History Is a Guide, Recession Is Inevitable in 2023
In 1981-82, the Federal Reserve tightened the money supply so severely that interest rates flirted with 20%. It was a radical plan that eventually worked, breaking the back of crippling inflation that had been battering the economy since the 1970s. The tradeoff was that the Fed’s action made a recession inevitable, but when the recession ended, the economic fever broke and a boom ensued.
Many analysts believe that the Fed is willingly striking the same bargain today.
“The Fed’s actions and projections indicate that not only is a recession inevitable but is being purposely engineered,” said Michael Weisz, president and co-founder of the alternative investment platform Yieldstreet. “The Fed’s expectations around both interest rate and unemployment levels suggest a tunnel vision approach to mitigating inflation — at the expense of the broader economy’s health.”
Recessions bring job losses, sinking stock prices, economic anxiety and hard times — but there might be no other way.
“Inflation is driven by an increase in money supply and the velocity of money, and also by expectations of further inflation,” said Zimmerman. “The very act of talking about inflation can lead to more inflation. Employee compensation expectations rise, which in turn causes prices to rise, and the cycle feeds upon itself. The only sure way out of this inflationary spiral is, unfortunately, to force the economy into a recession. Job losses will dampen employee expectations and reduce labor price pressures on companies, which in turn will lower input costs and enable companies to slow the pace of price increases.”
The idea is that as the economy enters a recessionary phase, consumers will become more cautious, saving more and spending less, reducing demand for products and further decreasing price pressure.
“To get to this point, we’ll need interest rates substantially higher than they are today, perhaps approaching or exceeding the pace of inflation,” said Zimmerman. “The sooner the Fed raises rates to these levels, the sooner we can curtail inflationary pressures and restore a more normal price environment for consumers.”
The Human Toll
Dr. Natasha Bhuyan, M.D., counsels patients on how their finances impact their health. She knows that inflation’s wrath goes beyond dollars, cents and interest rates.
“As finances remain top of mind for stressed consumers, the connection between inflation and worsening mental health has become increasingly apparent,” Bhuyan said. “I’ve heard from my patients that they feel pressured and experience a persistent sense of worry. Bills or even sticker shock at the grocery store can also act as triggers, presenting as symptoms like an inability to focus, appetite changes, or teeth clenching. This financial stress can turn into anxiety or depression, as what feels like everyday stress can evolve into generalized anxiety disorder. Mental health issues are the top condition I’m seeing as a family physician right now, and much of this is as a result of inflation and financial stress.”
She recommends visiting your family physician if you experience recurring financial anxiety.
“Other tools that can help when you’re dealing with financial stress include mindfulness, done through simple breathing exercises like box breathing or meditation, good sleep hygiene — at least seven hours per night and going to bed and waking up at the same time — and gratitude practice; keeping a journal, for example. Even in uncertain financial times, learning to cope with these challenges can help us keep our overall health intact.”
More From GOBankingRates