The cost of consumer products was a rare bright spot in the American economy for four decades. The items we use to fill our homes and livesphones, clothes, makeup, automobiles, snacks, and toyshave improved and become more affordable. But that is no longer the case. In February, prices were up 6.8% year over year, and they’re almost certain to rise even more in the following months. A new Great Inflation is putting pressure on family budgets, wiping off wage gains, and boosting the risk of economic stagnation or even recession. Given the powerful pressures driving up prices, costs are likely to rise more before leveling out.
The coronavirus pandemic is the first force: families are spending more on commodities and less on services, and global supply networks have yet to adjust to the new reality. People stopped attending to their personal trainers and started setting up garage gyms after COVID-19 hit. Families stopped eating out and instead bought air fryers and barbecue grills. That tendency has not changed two years later: consumer spending is still around 15% greater than it was before the pandemic, whereas consumer expenditure on services has not recovered.
At the same time that demand has grown, the pandemic has disrupted global supply of everything from fertilizer to lumber to medical equipment, making transportation up to ten times more expensive. Mines and industries have struggled to produce goods due to infections and lockdowns. For the past two years, semiconductor chips, which are utilized in almost every electronic device, have been in limited supply. The maritime industry, which relies on boats, locks, and robotics that take years to construct, has also failed to grow. “Shippers have struggled to find capacity, with severe shortages of vessel space, container boxes, chassis, warehouse space, intermodal capacity, and personnel,” according to a comprehensive McKinsey research.
The Omicron wave that is currently sweeping Asia is producing yet another wave of supply interruptions, raising the possibility of more shortages and price spikes. As instances began to rise, Chinese authorities placed the city of Shenzhen and the province of Jilin under lockdown earlier this month. Shenzhen is renowned as the world’s hardware capital; any protracted closures will upset the electronics industry, with ramifications in industries as diverse as auto manufacture and fast food.
COVID-19 has also disrupted supply closer to home, in the industrial industry and in the labor force. In what has been dubbed the “Great Resignation,” the pandemic has forced millions of senior workers into early retirement and convinced many younger workers to quit their bad jobs and look for new ones. Hundreds of thousands of parents, especially mothers, have been pushed out of the labor market as a result of child-care closures, while the epidemic has sickened or killed millions of workers and left countless disabled due to the catastrophic and poorly understood long COVID.
Despite this, the American economy has rebounded astonishingly well from the coronavirus recession, with unemployment currently at 4%, GDP fully recovered, and wages rising across the board. Given how slow the recovery from the Great Recession has been, this is fantastic news. However, the second major driver of the Great Inflation is a hot economy. Interest rates are near zero, and the Trump and Biden administrations have spent nearly $3 trillion on family and business assistance, including providing no-strings-attached monthly checks to practically every family with children in the second half of 2021. Consumers have an amazing propensity to spend, spend, and spendand corporations have more room to raise prices as a result of this burst of government generosity. In a February interview with CNBC, Brian Niccol, the CEO of Chipotle, said, “To date, we’ve encountered no backlash from our customers.”
With corporate profits approaching all-time highs, Democrats have argued that price gouging and greed are further factors driving today’s inflation rates. Jen Psaki, the White House press secretary, stated last week that “if gas retailers’ costs are coming down, they need to promptly pass those savings on to customers,” chastising energy companies for “any effort to abuse American consumers.” They claim that excessive corporate concentration is also at play: a lack of competition has allowed corporations to raise prices. Both statements are correct, but they don’t explain why prices are rising presently.
The invasion of Ukraine by Russia, on the other hand, does, and is a third big driver driving up prices this year. One of the world’s top energy exporters is attacking one of Europe’s largest agricultural exporters without provocation. In a short period of time, this means higher commodity prices, which means higher pricing for manufacturers, which means higher prices for merchants, which means higher prices for families. Perhaps much higher: In the first week of March, one indicator of raw material prices increased by 16 percent, the largest increase in half a century.
Sanctions against Russia, in general, and import bans on Russian gas, in particular, are driving up energy costs, which in turn are driving up the cost of all other items. Russia was the world’s largest exporter of natural gas last year, as well as the second-largest exporter of crude oil and the third-largest exporter of coal. According to Ryan Severino, chief economist at Jones Lang Lasalle, a worldwide real-estate and investment firm, “affordability is already degrading, and security and reliability are collapsing.” “In the short term, this means that customers will just pay more for whatever energy they can get for their urgent requirements.”
At the same time, the invasion has cut Ukraine off from Europe’s breadbasket: wheat, corn, and sunflower oil are no longer being exported from its Black Sea ports. As a result, wheat futures on the Chicago Board of Trade increased by the maximum allowed each of the first five days of March, and are already up over 40% since the invasion. Even if Russia were to leave Ukraine soon, those price rises would very certainly continue. The war is hurting the harvest season and causing damage to Ukraine’s maritime infrastructure, and the West is likely to keep sanctions against Russia in place for years.
How can inflation be slowed? Demand reduction or supply expansion are the two alternatives available to policymakers. The Federal Reserve raised interest rates this week in response to the latter. According to Jerome Powell, the Fed chair, there are 1.7 job vacancies for every unemployed person. “That’s a very, very tight labor market,” he said, describing it as “unhealthy.” “We’re attempting to better link supply and demand.” In response to geopolitical instability and the closure of many COVID-era expenditure programs, households and businesses are beginning to pull back on their own. In terms of the latter method for combating inflation, the White House is attempting to enhance energy production, both clean and dirty, as well as to smooth out supply chain kinks. However, there isn’t much Washington can do in the short term to increase capacity. The White House is also urging Americans to put up with high gas prices in order to penalize Russia and put pressure on it to leave Ukraine.
Households will just have to accept higher prices for the duration of the Great Inflation. Unfortunately, a recession is likely to put an end to it: In the past seven decades, whenever inflation has been this high and unemployment has been this low, one has followed within a year or two. Six of the last seven downturns have been preceded by price increases in gasoline. Geopolitical issues were a direct cause in four cases. Rising costs may not seem so bad if the economy collapses soon.
Is inflation or recession the worst?
Inflation can be difficult to manage once it begins. Consumers expect greater pay from their employers as prices rise, and firms pass on the higher labor costs by raising their pricing for goods and services. As a result, customers are having a tougher time making ends meet, therefore they ask for more money, etc. It goes round and round.
Inflationary pressures can be even severe than a recession. Everything gets more expensive every year, so if you’re on a fixed income, your purchasing power is dwindling. Inflation is also bad for savings and investments: a $1,000 deposit today will purchase less tomorrow, and even less next month.
What form of inflation triggers a downturn?
Low inflation typically indicates that demand for products and services is lower than it should be, slowing economic growth and lowering salaries. Low demand might even trigger a recession, resulting in higher unemployment, as we witnessed during the Great Recession a decade ago.
Deflation, or price declines, is extremely harmful. Consumers will put off buying while prices are falling. Why buy a new washing machine today if you could save money by waiting a few months?
Deflation also discourages lending because lower interest rates are associated with it. Lenders are unlikely to lend money at rates that provide them with a low return.
How can a recession bring inflation under control?
- Governments can fight inflation by imposing wage and price limits, but this can lead to a recession and job losses.
- Governments can also use a contractionary monetary policy to combat inflation by limiting the money supply in an economy by raising interest rates and lowering bond prices.
- Another measure used by governments to limit inflation is reserve requirements, which are the amounts of money banks are legally required to have on hand to cover withdrawals.
Is a recession characterised by deflation or inflation?
A recession is a time in which the economy grows at a negative rate. A drop in output (Real GDP) for two consecutive quarters is the official definition.
The rate of inflation has been decreasing since 2010. Prices are still rising, although at a slower pace.
Deflation
Since World War II, recessions have often not resulted in deflation, but rather in a decreased rate of inflation. Attempts to lower a high inflation rate triggered the two recessions of 1980 and 1991.
In May 2008, the RPI (which includes the cost of interest payments) fell below zero, indicating deflation. This deflation, however, did not endure long.
The United Kingdom underwent a significant period of deflation (lower prices) in the 1920s and 1930s as a result of the Great Depression.
- Overvaluation of the pound – The Gold Standard made imports cheaper but made exports less competitive.
Difference between Recession and Depression
Surprisingly, many people consider deflation to be an indication of depression rather than just a slump in the economy. (Another symptom of depression is a considerably larger and longer drop in GDP.)
What is creating 2021 inflation?
As fractured supply chains combined with increased consumer demand for secondhand vehicles and construction materials, 2021 saw the fastest annual price rise since the early 1980s.
What caused inflation in the 1970s?
- Rapid inflation occurs when the prices of goods and services in an economy grow rapidly, reducing savings’ buying power.
- In the 1970s, the United States had some of the highest rates of inflation in recent history, with interest rates increasing to nearly 20%.
- This decade of high inflation was fueled by central bank policy, the removal of the gold window, Keynesian economic policies, and market psychology.
What happens if inflation becomes excessively high?
If inflation continues to rise over an extended period of time, economists refer to this as hyperinflation. Expectations that prices will continue to rise fuel inflation, which lowers the real worth of each dollar in your wallet.
Spiraling prices can lead to a currency’s value collapsing in the most extreme instances imagine Zimbabwe in the late 2000s. People will want to spend any money they have as soon as possible, fearing that prices may rise, even if only temporarily.
Although the United States is far from this situation, central banks such as the Federal Reserve want to prevent it at all costs, so they normally intervene to attempt to curb inflation before it spirals out of control.
The issue is that the primary means of doing so is by rising interest rates, which slows the economy. If the Fed is compelled to raise interest rates too quickly, it might trigger a recession and increase unemployment, as happened in the United States in the early 1980s, when inflation was at its peak. Then-Fed head Paul Volcker was successful in bringing inflation down from a high of over 14% in 1980, but at the expense of double-digit unemployment rates.
Americans aren’t experiencing inflation anywhere near that level yet, but Jerome Powell, the Fed’s current chairman, is almost likely thinking about how to keep the country from getting there.
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Photo credit for the banner image:
Prices for used cars and trucks are up 31% year over year. David Zalubowski/AP Photo
Is depression linked to inflation?
Is it, however, too early for such pessimism? The magnitude of this shock is undeniable – the magnitude and speed of the drop in output is unprecedented and terrifying. If economies do not recover to their previous growth trajectory or rates, the coronavirus will leave a structural macroeconomic legacy. A macroeconomic shock even a severe one is a long way from a structural regime disruption, such as a depression or a debt crisis.
The key to a positive macroeconomic regime is price stability, therefore keep an eye on it. A break in the economy, such as a depression or a debt crisis, is characterised by a change to excessive deflation or inflation, and hence a disruption of the economy’s normal functioning. The US economy has enjoyed declining, low, and steady inflation for the previous 30 years, which has resulted in low interest rates, longer business cycles, and high asset valuations. However, if price stability is lost, the real and financial sectors will suffer greatly.
The Four Paths to a Structural Regime Break
Between a serious crisis and a systemic regime breakdown lie policy and politics. Failure to stop the negative trajectory of a crisis-ridden economy is due to persistently poor policy measures, which are anchored either in incompetence or political unwillingness. We’ve charted four stages that lead to a structural regime break, each shown with historical examples.
1. Error in Policy
The first step toward depression happens when politicians and policymakers attempt to identify and treat the problem theoretically. The Great Depression is a quintessential example of policy failure, as it was an enormous policy failure that aided not only the depth but also the length and legacy of the crisis. There were two conceptual misunderstandings:
- Errors in monetary policy and the banking crisis: Between 1929 and 1933, a lack of oversight of the banking sector, tight monetary policy, and bank runs resulted in thousands of bank collapses and massive losses to depositors. The collapse of the banking system stifled the flow of credit to businesses and individuals. Despite the fact that the Federal Reserve was established in 1913 to presumably combat such crises, it stood by as the banking system imploded, assuming that monetary policy was stable. In actuality, it was mired in a logical blunder.
- Politicians also stood by and let the economy bleed for far too long. The New Deal arrived too late to avoid the slump, and it offered insufficient relief. In 1937-38, when fiscal policy was tightened anew, the economy crashed once more. World War II eventually put an end to the Great Depression by dramatically increasing aggregate demand and even restoring economic output to pre-depression levels.
As a result of these policy errors, there was severe deflation (price level collapse) of well over 20%. While unemployment remained high, the nominal value of many assets fell substantially, while the real weight of most loans rose sharply, leaving households and businesses fighting to get back on their feet.
2. Political Determination
When the economic diagnosis is evident and the cures are recognized, but politicians stand in the way of a solution, the second path from a profound crisis to a depression occurs. More than understanding and thinking, it’s a problem of willingness.
We don’t have to search far to see an example of this danger: When the US Congress couldn’t agree on a way ahead in the global financial crisis in 2008, a lack of political will pushed the economy dangerously near to a deflationary depression.
Bank capital losses were building up by late 2008, causing a credit bottleneck that crippled the economy. The potential of a deflationary depression with a shaky financial system was genuine, as seen by collapsing inflation expectations throughout the crisis.
The most perilous moment occurred on September 29, 2008, when the House of Representatives rejected TARP, a $700 billion rescue package designed to recapitalize (or bail out) banks. The resulting market crash lowered the political cost of opposing TARP, and the bill was passed a few days later, on Oct. 3.
In effect, political will came together at the last possible moment to prevent a structural regime break and limit the structural legacy to a U-shaped shock. While the US economy recovered its growth rate after a few years, it never returned to its pre-crisis growth path, which is what a U-shaped shock is.
3. Policy Requirements
When policymakers lack operational autonomy, authority, or economic resources, a third possible path from acute crises to depression emerges. This occurs in countries or territories that lack monetary sovereignty, or central bank autonomy in other words, they can’t use the central bank to maintain a healthy credit flow even if their currency is stable in times of crisis. Internal depression, or price and wage deflation, is the only method for such economies to rebalance and overcome monetary dependence’s restrictions.
Greece’s relationship with the European Central Bank during the global financial crisis is perhaps the best example of such dependence. Because it was unable to obtain finance from the ECB, Greece was forced to enter a slump marked by significant deflationary pressures.
Rejection of Policy
The fourth option, unlike the previous three, leads to a debt crisis rather than a depression. In this instance, policymakers know what to do and have the political will to do it, but they are unable to generate the necessary real resources because the markets are rejecting their efforts. This path differs from the others in that it leads to high inflation rather than deflation.
In a recession, do prices drop?
Most markets, including real estate markets, experience price declines during recessions. Due to the current economic climate, there may be fewer homebuyers with disposable income. Home prices decline as demand falls, and real estate revenue remains stagnant. This is merely a general rule of thumb, and home values may not necessarily fall during real-world recessions, or they may fluctuate in both directions.