Inflation Is Real and It Is Here
Plus, a big bump is in store for Social Security recipients in 2022
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For much of the past year, Federal Reserve officials have been tempering worries about inflation by attributing the rise in prices to pandemic-related supply chain issues and labor shortages. The key word has been transitory, as Fed officials, economic analysts, and media commentators alike have all tried to reassure the public that inflationary pressures will eventually settle themselves out. But the rise in prices has not reversed. In fact, it has not even subsided.
This past Wednesday, newly released Consumer Price Index (CPI) numbers showed a rise in prices of 5.4% on a year-over-year basis, which followed a 5.3% increase in August. And most notably (and most unfortunately for many Americans), the rise has been made up of some of the most important expenses ordinary people face: food, housing, and energy prices.
What’s Happening
One of the key reasons for rising prices is robust demand, which is not necessarily a bad thing. There is always a fear of what is known as stagflation, which is inflation without economic growth. The United States and other parts of the world experienced this most notably during the 1970s. But consider another piece of data that was released this past week: retail sales rose 0.7% in September. Economists had only been projecting an increase of 0.2%, so the rise of 0.7% was a big number to the strong side. Stocks roared higher in response this week, with the S&P 500 posting its best week since July.
What the rise in retail sales shows is that the economy is rebounding. There is still significant pent-up demand among consumers for everything from home construction projects to travel and that demand is continuing to play itself out. Part of the story with inflation, then, is just that demand is so strong and consumers are willing and able to spend. It is a principal of economics that when demand among consumers for a particular good or service is strong, prices will rise in response.
Another factor on the inflation front right now is that governments around the world injected their economies with massive amounts of COVID-relief funds in order to help support their populations and provide a base for their economies. By some estimates the amount of global COVID stimulus funds are now in excess of $20 trillion (that’s trillion with a t). That’s a lot of new money flowing through the global economy. Not every economist necessarily agrees with the following premise, but traditionally it is believed and understood that when new money is created (actual new money, printed in the mints of governments around the world and injected into their economies), inflation will rise. And there is likely an element of that playing out now as there has just been so much COVID-related stimulus over the last 20 months around the world including here in the United States.
Now, to be sure, if most of the key decision makers around the world in charge of these economies were to be told a year ago that the biggest problems their countries would be facing in October 2020 was rising inflation rather than outright economic collapse, I think most would have been grateful and pleased. The global stimulus mostly worked: economies were propped up long-enough to make it through the worst of the COVID-induced recession and things have been rebounding.
And yes, supply chain issues are relevant here too, which is a topic that has been all over the news of late and one that I intend to devote a future article about. Goods are not able to reach markets fast enough and companies are increasing their prices for the items that do make it to the shelf, but ultimately this is still just as much (if not more) about the demand side of the equation than the supply side. Supply chain issues abound, but it is partially because the demand side is so strong and supply chains are knotted up trying to meet that demand.
What’s Inflating
Many of things the things that are rising the most in price are the most important expenditures in the family budgets of many households. In the month of September:
Gas was up 1.2% and is now up 42.1% for the year
Food prices were up 1.2%
Rents were up 0.4% (don’t be fooled by the small percentage here; on an annualized basis a jump in 0.4% in this category is significant)
There may be more pain on the horizon, as heating oil prices throughout the country are expected to surge this winter. Officials warned this week that some households in certain parts of the country could see natural gas prices rise by as much as 54%! (A silver lining for readers and residents in the Northeast: natural gas prices are only projected to increase by 14% here).
Wage Inflation
The discussion of rising wages is a topic worthy of its own discussion, perhaps in a future week. But wage pressure is real. People are switching jobs more frequently than ever because there are so many opportunities right now, and companies are raising wages and benefits for workers at all points on the salary spectrum to attract and retain talent. According to the St. Louis Federal Reserve, the average annual earnings for American workers in September 2021 was $30.85, up nearly a full dollar since January and up from $28.15 in September 2019 before the pandemic.
On the income front, there is good news for Social Security recipients: in 2022 they are going to receive the biggest bump in benefits in 40 years! Per The New York Post:
The cost-of-living adjustment (COLA) for Social Security benefit receipts will increase by 5.9 percent in 2022. The number only increased by 1.3 percent in 2021. This will average out to a roughly $92 increase for each retiree per month, bringing the total to $1,657. Retired couples will see an increase of $154 per month.
To help pay for the increase, the Social Security tax wage base is increasing from $142,800 to $147,000, so people earning this amount of money (or more) are going to be paying in a little bit more to help cover that 5.9% increase in benefits.
As I said in my last article on inflation, while most inflation is generally bad, some aspects of inflation can be good, particularly to certain people or categories of people. Certainly the bump up in monthly benefits for many Social Security recipients will be welcome news even in the face of rising inflation for all manner of expenses.
What Comes Next
When gas, food, and housing are all rising in price the way they are, it is going to take a toll on people’s personal budgets, which in turn will have an impact on the economy. The Federal Reserve, which is tasked with both promoting employment and limiting inflation, is in a bind. If they raise interest rates to stave off inflation, it risks having an even more detrimental impact on the economy as rising interest rates are also likely to slow growth. But if the Fed does nothing and inflation continues to rear its ugly head, that, too, will be a drag on growth. The Fed seems to be banking on its most optimistic path possible, which is the hope that inflation will settle out on its own as supply chain issues shake out and the Fed won’t have to decide whether to accelerate interest rate hikes faster than they want to (the Fed has previously said they don’t anticipate raising interest rates until 2023).
My Take
The economy has been doing better than most people expected it would, although I don’t think most people actually thought COVID would still be with us and as robustly so 20 months after it first hit the United States in the first quarter of 2020. The real estate market and the stock market have both been on fire. But we are at a bit of a perilous moment.
In a Gallup poll on the economy for the first half of September, only 25% of those polled rated the economy as “excellent” or “good.” A full 74% of those polled, however, rated the economy as “only fair” or “poor.” These numbers are quite negative overall and reflect more pessimistic views than one month prior, one year prior, and certainly as compared to pre-pandemic levels. By comparison, in September 2019, 50% of those polled were optimistic about the economy while 50% said it was “only fair” or “poor.”
If people are not feeling confident in the economy, which is natural when the prices of so many key aspects of daily life are rising and with more increases on the horizon, consumers will pull back. This produces a downward cycle that can feed upon itself: pessimism leads to economic wariness, which can lead to less spending, which leads to overall economic weakness, which leads to pessmism, and so on and so forth.
So how do policymakers get a handle on inflation? Well, there are certain macroeconomic factors that are hard to move the needle on. Interest rates are a key lever, but as noted above, if the Fed increases rates it has other far-reaching effects on the economy that may not be all that positive. Supply chain issues can not be completely cleared up through policy but policy can help around the edges, which it appears the Biden Administration is trying to do by announcing that the Port of Los Angeles, for example, will start operating twenty-four hours a day. But for now, the Fed seems to be trying to strike the balance as best it can between keeping interest rates low in order to stoke economic activity, which will promote stronger employment and overall economic growth, without letting inflation start to hit runaway levels. In my opinion, rates have been held low for a particularly long time and the Fed may need to hike rates sooner than 2023.
Ben Sprague lives and works in Bangor, Maine as a V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram and subscribe to this weekly newsletter by clicking below.
Author’s Note: I had a busy week of campaigning for school committee in my hometown of Bangor, Maine (Election Day is November 2nd) and coaching my son and daughter’s soccer teams. So there is no weekly round-up this week, just this one tweet that made me smile while I was writing this week’s article:
Have a great week, everybody!