Inflation Nears a Peak, but Will Prices Come Down Anytime Soon?

Banking & Finance

Inflation continues to keep prices high across the country, but the latest Consumer Price Index statistics indicate that its pace is slowing. The new CPI data shows that consumer prices across the board rose only 0.3% in April, bringing the 12-month inflation rate down slightly to 8.3% from 8.5% in March.

Although gasoline prices have been a big contributor to the rise of inflation in 2022, the latest CPI shows a shift. Gas prices were down 6.1% last month, whereas increases in costs for rent, airline tickets and new vehicles contributed most to inflation in April.

Inflation refers to a currency’s weakening purchase power over time. During a period of inflation, a dollar will buy less tomorrow than it will today. As an economic factor, inflation isn’t necessarily good or bad. When moderated, it encourages spending and a healthy economy.

Rising prices have spurred President Joe Biden and the Federal Reserve to both take steps to ease the pain of inflation for Americans. Last week, the Federal Reserve announced a 0.5% increase in the federal funds rate, the largest hike in 20 years. On Tuesday, President Biden addressed inflation with public remarks explaining his broad plan to “lower everyday costs for hardworking families.”

Why does inflation occur and how does economic policy affect rising prices? Read on to learn more about inflation, including how it can impact your budget and your spending power.

Simply put, inflation is a sustained increase in consumer prices. It means a dollar bill doesn’t get you as much as it did before, whether you’re at the grocery store or a used car lot.

Inflation is usually caused by either increased demand — such as COVID-wary consumers being finally ready to leave their homes and spend money — or supply-side factors like increases in production costs. 

Inflation is a given over the long term, and it requires historical context to mean anything. For example, in 1985, the cost of a movie ticket was $3.55. Today, watching a film in the theater will easily cost you $13 for the ticket alone — never mind the popcorn, candy or soda. A $20 bill in 1985 would buy you almost four times what it buys today.

Typically, we see a 2% inflation rate from year to year. It’s when the rate rises above this percentage in a short period of time that inflation becomes a concern.

Over the past century, there have only been a few years when the annual inflation rate in the US has been a negative number. But we also measure inflation in the short term, where we can see sharper rises, such as the price increase for used cars and trucks in June 2021. At that time, the CPI stated that prices shot up by 10.5% in just one month — a dramatic increase that has since petered out, with monthly price changes for used cars dipping into the negatives the following months.

Inflation isn’t a physical phenomenon we can observe. It’s an idea that’s backed by a consensus of experts who rely on market indexes and research. 

One of the most closely watched gauges of US inflation is the Consumer Price Index, which is produced by the federal Bureau of Labor Statistics and based on the diaries of urban shoppers. CPI reports track data on 80,000 products, including food, education, energy, medical care and fuel.

The BLS also puts together a Producer Price Index, which tracks inflation more from the perspective of the producers of consumer goods. The PPI measures changes in seller prices reported by industries like manufacturing, agriculture, construction, natural gas and electricity.

And there’s also the Personal Consumption Expenditures price index, prepared by the Bureau of Economic Analysis, which tends to be a broader measure, because it includes all goods and services consumed, whether they’re bought by consumers, employers or federal programs on consumers’ behalf. 

The current inflationary period generally started when the Labor Department announced that the CPI increased by 5% in May 2021, following an increase of 5% in April of the same year — a rise that caused a stir among market watchers

But that rise in the CPI, in and of itself, doesn’t mean we’re necessarily in a cycle of rising inflation. That’s where the Federal Reserve comes in.

The Fed, created in 1913, is the control center for the US banking system and handles the country’s monetary policy. It’s made up of 12 regional Federal Reserve banks and 24 branches and run by a board of governors, all of whom are voting members of the Federal Open Market Committee, which is the Fed’s monetary policymaking body.

While the BLS reports on inflation, the Fed moderates inflation and employment rates by managing the supply of money and setting interest rates. Part of its mission is to keep average inflation at a steady 2% rate. It’s a delicate balancing act, and the main lever it can pull is to adjust interest rates. In general, when interest rates are low, the economy and inflation grow. And when interest rates are high, the economy and inflation slow. 

With rates well over the 2% inflation goal, the Fed raised interest rates a quarter point in March and raised them again by a half point on May 4.

Maybe, though it’s too soon to say. While you’re seeing the cost of day-to-day living go up, it’s possible that’s the normal and expected response to the previously stalled-out pandemic economy, which is rapidly strengthening.

There’s been no consensus among experts that inflation will maintain a sustained cycle and become entrenched. However, the accelerating pace of inflation in 2022 — and the fact that it’s seeping into portions of the economy undisturbed by the pandemic — could mean the situation is worse than originally thought. 

It’s worth noting that the Fed has been generally successful in keeping inflation at or below its target of 2% for almost a decade. But these are unprecedented times, and this is definitely an issue to keep an eye on.

There are a few other “flations” worth knowing about. Let’s brush up.

As the name infers, deflation is the opposite of inflation. Economic deflation is when the cost of living goes down. (We saw this, for example, during parts of 2020.) Widespread deflation can have a devastating impact on an economy. Throughout US history, deflation tends to accompany economic crises. Deflation can portend an oncoming recession as consumers tend to halt buying in hopes that prices will continue to fall, thus creating a drop in demand. Eventually, this leads to consumers spending even less, lower wages and higher unemployment rates. 

This economic cycle is similar to inflation in that it involves an increase in the cost of living. However, unlike inflation, hyperinflation takes place rapidly and is out of control. Many economists define hyperinflation as the increase in prices by 1,000% per year. Hyperinflation is uncommon in developed countries like the US. But remember Venezuela’s economic collapse in 2018? That was due in part to the country’s inflation rate hitting more than 1,000,000%.

Tangentially related to inflation, shrinkflation refers to the practice of companies decreasing the size of their products while keeping the same prices. The effect is identical to inflation — your dollar has less spending power — and becomes a double whammy when your dollar is already weaker. Granola bars, drink bottles and rolls of toilet paper have all been caught shrinking in recent months.

Stagflation is when the economy enters a period of stagnation. In these instances, unemployment is high, prices are rising and economic growth is slow. Stagflation was first recognized in the 1970s after the energy crisis. Simultaneously, inflation doubled, the US experienced negative GDP growth and unemployment reached 9%. Memories of this dark economic time factor into current fears of inflation spiraling out of control, even though the circumstances are very different. 

Michelle Meyers and Justin Jaffe contributed to this report.

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