As price increases spread across the US, inflation has reached a new 40-year high

Consumer prices rose 8.6% year over year through May, according to the government, the sharpest rate of increase in four decades. Food, fuel, and housing are becoming more expensive in the United States, and many people are seeking answers as to what is causing the price spike, how long it will persist, and what can be done to address it.

Here’s how to figure out what’s going on with inflation and how to think about price increases as you navigate this tumultuous period in the US and global economies.

What Causes Inflation?

It may be instructive to categorise the reasons of today’s inflation into three categories.

High demand: Consumers are spending a lot of money. Households saved money early in the epidemic because they were stuck at home, and government assistance that lasted until 2021 helped them save even more. People are now taking jobs and obtaining pay raises. All of these variables have given families more money to spend on things like backyard grills and beach vacations, as well as vehicles and kitchen tables.

There aren’t enough items: Families have stumbled into a difficulty as they try to buy pickup trucks and computer screens with their pandemic savings: there aren’t enough goods to go around. Factory closures linked to the pandemic, worldwide shipping backlogs, and reduced output have all contributed to a parts and product shortage. Because demand for goods has outstripped supply, businesses have been able to raise prices without losing customers.

China’s most recent restrictions are worsening supply chain snarls. At the same time, the war in Ukraine is depleting the world’s food and fuel supplies, driving up general inflation and increasing the cost of other goods and services. Gas prices in the United States are averaging around $5 per gallon, up from just over $3 a year ago.

Pressures in the service sector: As individuals acclimate to living with the coronavirus, they’ve been diverting their spending away from items and toward experiences, and inflation in service industries has been rising. Rents are rapidly rising as Americans fight for a limited supply of residences, restaurant bills are rising as food and labour expenses rise, and plane tickets and hotel rooms are becoming more expensive as people become more willing to travel and as fuel and labour costs grow.

Perhaps you’re asking what part corporate greed plays in all of this. True, businesses have been making extraordinarily large profits by raising prices more than necessary to offset rising costs. However, companies are able to do so in part because demand is so robust – customers are willing to spend even as prices rise.

How we measure inflation?

Economists and policymakers are keeping a careful eye on the Consumer Price Index and the Personal Consumption Expenditures index, both of which were reported on Friday.

The C.P.I. measures how much consumers pay for goods and services, and it is released earlier each month, giving the nation its first clear picture of how inflation performed the previous month. The P.C.E. values are also calculated using data from the index.

The P.C.E. index, which will be issued on June 30, measures how much products cost in reality. It counts the cost of health-care operations, for example, even though the government and insurance companies help pay for them. It has a lower volatility and is the index that the Federal Reserve uses to try to attain 2% inflation on average over time. The P.C.E. index was up 6.3 percent in April compared to the previous year, more than three times the central bank’s aim.

To obtain a sense of inflation’s momentum, Fed officials are paying particular attention to variations in month-to-month inflation.

The so-called core inflation figure, which excludes food and fuel prices, is also closely watched by policymakers. While groceries and petrol account for a significant portion of household budgets, their prices fluctuate in reaction to fluctuations in global supply. As a result, they don’t provide a good picture of the economy’s underlying inflationary forces, which the Fed believes it can address.

“I’m going to be looking to see a consistent string of decelerating monthly prints on core inflation before I’m going to feel more confident that we’re getting to the kind of inflation trajectory that’s going to get us back to our 2 percent goal,” Lael Brainard, the vice chair of the Fed and one of its key public messengers, said during a CNBC interview last week.

What Can Be Done to Slow the Price Increases?

Nobody knows how long prices will continue to rise at this rate: Since the epidemic began in 2020, inflation has baffled specialists on numerous occasions. However, based on the factors driving today’s high prices, a few possibilities seem likely.

For one thing, rapid inflation does not appear to be going away on its own. Wages are rising at a significantly faster rate than usual. That means that unless businesses become more efficient overnight, they will most likely continue to raise prices to pay their labour costs.

As a result, the Federal Reserve is hiking interest rates to stifle demand and reduce wage and price rise. As a result of the central bank’s policy response, the economy is almost certainly destined for a slowdown. Higher borrowing costs have already started to damper the housing market.

The question is how much Fed intervention will be required to bring inflation under control, which is fraught with uncertainty. If the United States is fortunate and supply chain problems subside, the Fed may be able to gently slow the economy, tempering wage increases without precipitating a recession.