One in four Americans believes inflation is the most important issue facing the U.S. economy, new polling data show.
Twenty-six percent of respondents to a late June survey by PBS NewsHour, NPR and Marist said inflation was their top economic concern, ahead of wages, unemployment and housing costs.
Dr. Antonio Saravia, associate professor of economics and director of the Center for the Study of Economics and Liberty in the Stetson-Hatcher School of Business at Mercer University, explains what causes inflation, why it’s worrisome, and what might be coming in the future.
What is inflation?
Inflation is the rise in the overall price level. The most popular indicator of this is the Consumer Price Index, which measures the change in prices paid by consumers for goods and services.
“If we see that the Consumer Price Index is increasing, then we say that there is inflation,” Dr. Saravia said.
The inflation rate in the United States generally has been below 5% since the 1980s, he said.
But that changed in May when the price of goods and services rose 5% over last year. It was the largest 12-month increase since August 2008 when it rose 5.4%, according to a U.S. Bureau of Labor Statistics report. That figure was tied in June, when the Consumer Price Index increased 5.4%.
“The problem with inflation, or why economists don’t like inflation, is because it creates uncertainty,” Dr. Saravia said. “We don’t know what to expect. If there is significant inflation, we don’t know if a month from now what I put aside to buy a car would be enough. That can be a problem at a personal level, but it can be a lot worse for companies.
“Think of a company that is making decisions about buying supplies in bulk by the millions. If they don’t have the certainty that prices are going to remain more or less constant, then it’s very difficult for them to plan.”
The company may decide to wait until the market is more stable, which means that investment decisions are canceled or at least postponed. That leads to no hiring and loss of production, he said.
Why is there inflation now?
Inflation is a “monetary phenomenon,” Dr. Saravia said.
“If we have more money circulating in the economy, we will have inflation,” he said.
In an effort to pull the country out of a recession brought on by the COVID-19 pandemic, the Federal Reserve, which is the central bank of the United States, and the federal government injected money into the economy.
The Fed did this by offering $2.3 trillion dollars in loans, which it is able to do by printing more money. This increases the money supply and lowers the interest rate, Dr. Saravia said.
Meanwhile, the federal government approved three stimulus packages totaling about $5 trillion, which included direct payments to Americans.
“You have these two sources of money going into the economy — and we’re talking about massive, massive amounts of money,” Dr. Saravia said. “On one hand, we receive these checks, and then on the other hand, we have money that is cheap because the interest rate continues to be low.
“So what do we do as consumers? We spend.”
But while consumers have this extra cash now, they should be careful about how they use it, he said.
“The problem is timing,” he said. “During an inflationary process, salaries may not go up as fast as the rest of the prices. They will eventually catch up, but if they lag behind for a period of time, then we may see that our purchasing power goes down.”
In addition, consumers should be cautious about making large purchases, like a house, or adding credit card debt while interest rates are low, he said.
“We are in the middle of a new housing bubble fueled by the low interest rates,” he said. “Don’t just continue to spend and put things on credit because it is cheap at the moment. Eventually, you’re going to have to pay for that.”
In addition, recent disruptions to the supply chain have increased the price of raw materials like lumber and other commodities, putting extra pressure on prices, Dr. Saravia said.
What will happen in the future?
Right now, the Fed is monitoring the situation.
In a deviation from long-held policy, the Fed has changed its target rate of below 2% annual inflation to below 2% over time. Over what period of time is unclear, Dr. Saravia said, but it could be five or 10 years.
“Why are they moving away from a strict target to a more flexible one? What’s happening is that the Fed is very well aware that its actions and the actions of the federal government are going to create inflation. The Fed is essentially admitting that we are in a period in which higher-than-normal inflation is going to be the norm,” he said.
But at some point, the Fed will have to step in to control rising prices by ceasing to print more money and raising the interest rate, Dr. Saravia said. That could be painful, he said.
“It’s like if you get addicted to something and you’re running with this substance, and all of a sudden you have to do a cold turkey stop,” he said. “You know it’s going to be good for you in the long run, but in the short run, it’s going to be very, very painful.”
Ending inflation is an art, and some changes could be done gradually to make it less painful, but Dr. Saravia still predicts that when that happens, the U.S. economy will fall into a short recession.
“I think we’re going to have to pay for the money printing and the massive stimulus one way or another,” he said.