Ever since Covid, America is facing high oscillating waves of price hikes. Did you know, the US recorded a 41-year high inflation rate of 9% last year? It resulted in a strong shock to the supply chain in the country leading to inflation in US.
Thankfully, as per the data of the US Labor Department, the annual inflation rate has come down to 4.9% in May 2023. But that’s not a sign of relief! Because the countrymen are facing a horrible scenario due to fueling inflation in US. It began with fuel/gas prices, new cars, and apartments. But the pie grew bigger & bigger affecting the prices of groceries and eatables like chickens & beef. Now the question is what are the main reasons behind this incessant inflation in US? In this article, you will get to know it by diving deep into the current US economy.
What is Inflation?
Let’s look at the definition- “Inflation refers to the general increase in prices of goods and services over time, resulting in a decrease in purchasing power. Several factors can contribute to inflation, and it’s often a complex interplay of various economic forces.”
Don’t worry! Let me explain it in simple terms.
Inflation is like a giant tug-of-war between money and goods. Right now, there’s a lot of money floating around in the US, like an ocean of cash. And people are excited to spend it, like kids in a candy store. But guess what? There’s not enough candy for everyone! The demand for goods and services is super high, but the supply can’t keep up. So, to make things fair, sellers raise their prices. It’s like a game of tag, but with dollars. And when prices keep going up, that’s called inflation. So, to keep the game balanced, the government tries to manage the money supply and keep inflation in check. We will explain the causes of inflation in US economy further. Before that, have a look at the timeline given in the next section.
Timeline of Inflation in US Economy
Observe the timeline below. It describes the factors that fueled it in each month ever since the post-pandemic period. Let’s delve into the brief history that led to the current situation in the US economy. (Data Source: U.S. Bureau of Labor Statistics)
- The year 2020: Energy prices crashed due to covid-19. (Inflation rate= 1.2%)
- February 2021: Energy prices returned to pre-pandemic levels on Feb 21 after crashing gas prices during the pandemic. (Inflation rate= 1.7%)
- April 2021: Coronavirus vaccine became available spurring increased demands for travel and dining. Used-vehicle prices jumped high due to delays in the manufacturing and sales of new vehicles. Also, wages grew by 3.2%. (Inflation rate= 4.2%)
- May 2021: Federal Reserve Interest rate was lowered to 0.75%-1.00%. (Inflation rate= 5.0%)
- July 2021: “Labor shortages + high transportation costs” collided with increased “consumer demand + restaurant demand + global market demand.” As a result, the overall cost of groceries and eatables increased. (Inflation rate= 5.4%)
- October 2021: Delta Wave occurred. Demand for used vehicles, travel, and dining declined. (Inflation rate= 6.2%)
- November 2021: Oil demand increased more than supply. Energy prices increased. US President has to release oil from the Strategic Petroleum Reserve (Inflation rate= 7.0%)
- February 2022: Russia invaded Ukraine. As a result, energy prices spiked across the world because Russia was the major supplier of fossil fuels in the globe. (Inflation rate= 7.9%)
- June 2022: Shortages of fertilizer from Ukraine along with summer droughts in the US. It led to poor harvests in the country. (Inflation rate= 9%)
- November 2022: A new tick-borne disease killed enormous cattle in US. It threatened the livestock industry. (Inflation rate= 7.1%)
- December 2022: The above factors contributed to an exponential rise in groceries, dairy products, and meat. (Inflation rate= 6.5%)
- April 2023: Mortgage rates rose extremely high. As a result, it increased pressure on the housing market. Housing costs continue to rise reflecting dramatic rent increases. This is putting homeownership out of reach for many Americans. (Inflation rate= 4.9%)
- May 2023: the cost of groceries, eatables, and energy (fuel) hasn’t come down yet.
Causes of Inflation in US Economy
Here comes the critical part of this write-up. After seeing the timeline, you might have got a brief idea about the reasons that are causing the inflation in US. Although major ones are Covid and Russia-Ukraine war. But did you look at the other factors too? Such as huge gas in demand & supply, summer droughts, and tick-borne diseases. Well, these are the obvious reasons that indirectly caused inflation in US. Now, let’s look into the crucial reasons that directly led to inflation in the so-called “most advanced/powerful country” in the world.
1. Demand-Pull Inflation
When aggregate demand exceeds the available supply of goods and services, it can lead to demand-pull inflation. This situation can arise due to various factors, such as increased consumer spending, expansionary fiscal or monetary policies, or increased business investment. If you look at the timeline, you will observe that the demand-pull inflation began in April 2021. The demand for travel and dining rose while the manufacturing sector was still low due to backlogs of work orders.
2. Cost-Push Inflation
It is caused by supply-side factors. Disruptions in the supply chain or a decrease in the availability of key inputs, such as raw materials, energy, or labor lead to cost-push inflation. Supply-side shocks significantly impact production and increase costs. These increased costs are often passed on to consumers in the form of higher prices. The shocks on the supply side include the following-
- Pandemic– Covid-19 in 2020-21
- Natural disasters– Summer drought in the US in June 2022
- Geopolitical tensions– Russia-Ukraine War in February 2022
- Diseases– Coronavirus disease in 2020-21, tick-borne disease in cattle in November 2022
- Shortages of workers/laborers: Increase in the unemployment rate.
3. Wage Growth
If wages increase significantly and outpace productivity growth, it can lead to higher production costs for businesses. To maintain their profit margins, businesses may pass these increased costs onto consumers through higher prices. This scenario occurred in April 2021. At that time the inflation was 4.2% whereas the wages rose by 3.2%. This wage growth was surpassed by the customers through the high price of goods. This was a major cause of this financial crisis at that time.
4. Monetary Policy
The actions of the Federal Reserve, the central bank of the United States, play a crucial role in managing inflation. By adjusting interest rates and implementing monetary policies, the Federal Reserve aims to influence borrowing costs, employment levels, and price hike. Expansionary monetary policies, such as lowering interest rates or increasing the money supply, can stimulate economic growth but may also contribute to inflationary pressures.
Do you know what the Federal Reserve interest rate was in May 2022? It was 0.75%-1.00%! This was a key contributor to inflation in that year. At that time, the inflation rate steeply increased to 5.0%. To combat this, the Federal Reserve increased the interest rates. As of now, the rate of interest is 5.00% to 5.25%. This may help to reduce the inflation rate to some extent.
5. Fiscal Policy
Government spending and taxation policies, known as fiscal policy, can also impact inflation. Expansionary fiscal policies, such as increased government spending or tax cuts, can stimulate demand but may put upward pressure on prices if the economy is already operating near its full capacity. According to U.S. Government Accountability Office, the following data was released. At the end of FY 2022, the federal debt of the public was about 97% of the GDP. Although, the federal deficit in FY 2022 decreased by 50% from FY 2021 to $1.4 trillion. But it was still the fourth-largest deficit in U.S. history.
6. Exchange Rates
Fluctuations in the value of the U.S. dollar compared to other currencies can influence the prices of imported goods. A weaker dollar makes imports more expensive, potentially leading to inflation if consumers and businesses rely heavily on imported products. The import and export price indices of US reveal that its weaker exchange rate heavily impacted the imports to and exports from the USA.
7. Debt Ceiling
The USA is undergoing a severe debt ceiling crisis. It refers to the maximum amount of money that the US can borrow by issuing bonds in a cumulative way. Although it doesn’t cause inflation directly. However, when the debt ceiling is reached and the government is unable to borrow more money to meet its obligations, it can lead to a series of financial disruptions. This can erode investor confidence and cause market uncertainty, potentially leading to higher borrowing costs for the government, businesses, and individuals.
Then how come the “Debt Ceiling” is counted as a cause of inflation? You may ask. Imagine, if the government resorts to printing more money to cover its expenses, it can increase the money supply. This, in turn, can contribute to this economic crisis. Therefore, while the debt ceiling alone does not cause inflation, the economic consequences of hitting the debt ceiling can indirectly contribute to inflationary pressures.
Let’s look at the current scenario. The US national debt has soared high. The treasury department had to borrow more and more money to pay for the spending on the government’s behalf. Economists have issued warnings about the dire consequences if Congress cannot suspend or put a limit on borrowing (debt ceiling).
Impact of Inflation in US on the world
Inflation in US is like a big wave that shakes the whole world. When it lands on such, it creates ripples that spread worldwide. Other countries feel the effects. Trade puzzles get shaken up as American products become pricier. Prices for things like oil and food rise, affecting everyone. Investors get interested in the US, so money flows away from other countries. Higher interest rates in the United States attract global investors seeking better returns, potentially leading to capital outflows from other countries. This can impact emerging economies and other nations reliant on foreign investments.
It’s like a financial disaster! Not only does it lead to recession, layoffs, and bank collapses. But the developing nations also struggle with debts as the American inflation wave grows stronger. Central banks try to keep everything balanced.
How is the current “Covid-19 Recession 2022-23” different from the “Great Recession 2008-09”?
None of us are unaware of the disaster brought by the collapse of Lehman Brothers. The “Great American Recession 2008” that impacted the world was triggered by the collapse of the housing market due to banking losses. While the current recession is caused by several factors including the pandemic, geopolitical crisis, and turmoil in the banking sector. Let’s compare the “Great American Recession-2008” with the current “Covid-19 Recession- 2023.”
|Particulars (Consequences of Recession)||2008 “The Great American Recession”||2023 “Covid-19 Recession”|
|Principal Causing Factor||The collapse of the housing market due to banking losses||Pandemic & Geopolitical Crisis|
|Fall of US GDP||4.3%||1.2%|
|Inflation rate||2.85% (2007) & 3.84% (2008)||9% (2022) & 4.9% (2023)|
As you can see, in 2008 the US’s GDP fell by 4.3% and the unemployment rate reached 10%. The inflation rate in 2007 and 2008 was 2.85% and 3.84% respectively. Although it was much lower than that of the years 2022 & 2023 i.e. 9% and 4.9% respectively. Also, the current unemployment rate in the US is 3.40%.
Now the question arises, will we see the same thunderstorm this year as that of 2008? Although it may seem like that. But as per CNN, 2023 won’t see a thunderous impact like the one that sunk the world’s economy in 2008. Really? How is it possible? The current inflation is much higher than that of 2008. According to experts, the recession of 2023 will greatly differ from that of 2008. Let’s look at the following points to get the answer-
- Unlike in 2007-08, the fundamentals of the current housing market are healthy.
- Banks learned a lesson from the risky lending practices of the Great Recession of 2008.
- Government regulations and interventions have increased.
However, certain things are going to be similar. Such as the rise in prices of commodities, job losses, plunging stock prices, etc.
Some of the preventive measures that can help you to tackle the current recession are-
- Diversification of investment portfolio in different asset classes like stocks, bonds, and commodities.
- Increased government regulation on digital currencies to oversight & prevent any future financial crisis. The regulations can prevent risky lending practices that can lead to economic instability.
- Having an emergency fund can help individuals as well as companies to protect themselves from financial storms. And that too without the need to liquidate investments at a loss.
It’s time to wrap up! US Economy is toiling to get back on track. As you have seen above, it managed the inflation rate from 9% in 2022 to 4.9% in 2023. Various factors contributed to such financial crisis in US. Some of the crucial ones are demand-pull inflation, cost-push inflation, wage growth, monetary policy, fiscal policy, exchange rates, debit ceiling, etc. Thus, inflation in the United States may trigger volatility in stock prices, bond yields, and currency valuations, affecting global investors and markets worldwide. Let’s hope that US economy will recover from inflation soon!