If you pay attention to financial news, you are probably seeing a lot of discussion about inflation, which has reared its head in the U.S. economy after being mostly dormant for the last decade. In May 2021, the Consumer Price Index rose at an annual rate of 5%, the highest 12-month increase since August 2008.1
You have likely seen price increases in some of the goods and services you purchase, and if so it’s natural to be concerned.
The larger question is: are these price increases temporary, caused by factors such as supply-chain issues and labor shortages that will be resolved as the economy continues to emerge from the pandemic? Or, do they indicate a fundamental imbalance that could cause widespread long-term inflation and hold back economic growth?
Most economists — including Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen — believe the current spike is primarily due to transitory factors that will fade in the coming months. One example of this, cited by Powell in a recent press conference, is the price of lumber.2
Supply and Demand
Early in the pandemic, many lumber mills shut down or cut back on production because they expected a major slowdown in building. To their surprise, demand for housing and home renovation increased during the pandemic, as many people who worked from home wanted more space, a different location, or improvements to their current homes. Low supply and high demand sent lumber prices soaring.
Sawmills geared up as quickly as they could and were reaching full capacity just as demand began to ebb, with builders cutting back due to high prices and homeowners using their discretionary income to buy other goods and services. The lumber story also suggests that consumers and businesses will cut back on spending for a product that becomes too expensive rather than spend at any price and feed an inflationary spiral.3
Fundamental Forces
Discrepancies between supply and demand are to be expected as the economy reopens, and most are likely to work themselves out in the marketplace. However, other forces could also drive inflation. Massive federal stimulus packages have provided consumers with more money to spend, while ongoing stimulus from the Federal Reserve has increased the money supply and made it easier to borrow.
Although unemployment is still relatively high, millions of jobs remain open as workers are hesitant to return to positions they consider unsafe in light of the pandemic, are unable to work due to lack of childcare, and/or are rethinking their careers in a post-pandemic world. This may change in September as extended unemployment benefits expire and children return to school, but the current imbalance is forcing many businesses to raise wages, especially in lower-paying jobs.4
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1. U.S. Bureau of Labor Statistics, 2021
2. Federal Reserve, 2021
3. Bloomberg, June 5, 2021
4. The New York Times, June 21, 2021
