Why do things cost so much?

Paul Wiseman
The Associated Press

WASHINGTON — Last year, it was a nasty surprise. And it wasn’t supposed to last. But now, inflation has become an ongoing financial strain for millions of Americans filling up at the gas station, lined up at a grocery checkout lane, shopping for clothes, bargaining for a car or paying monthly rent.

For the 12 months ending in January, inflation amounted to 7.5% — the fastest year-over-year pace since 1982 — the Labor Department said Thursday. Even if you toss out volatile food and energy prices, so-called core inflation jumped 6% over the past year. That was also the sharpest such jump in four decades.

Consumers felt the price squeeze in everyday routines. Over the past year, prices rose 41% for used cars and trucks, 40% for gasoline, 18% for bacon, 14% for bedroom furniture, 11% for women’s dresses.

The Federal Reserve didn’t anticipate an inflation wave this severe or this persistent. In December 2020, the Fed’s policymakers had forecast that consumer inflation would stay below their 2% annual target and end 2021 at around 1.8%.

Bigger than expected: But after having been an economic afterthought for decades, high inflation reasserted itself last year with brutal speed. In February 2021, the government’s consumer price index was running just 1.7% ahead of its level a year earlier. From there, the year-over-year price increases accelerated steadily — 2.7% in March, 4.2% in April, 4.9% in May, 5.3% in June.

By October, the figure was 6.2%, by November 6.8%, by December 7.1%.

For months, Fed Chair Jerome Powell and others characterized higher consumer prices as merely a “transitory” problem — the result, mainly, of shipping delays and temporary shortages of supplies and workers as the economy rebounded from the pandemic recession much faster than anyone had anticipated.

Now, many economists expect consumer inflation to remain elevated well into this year,

with demand outstripping supplies in numerous areas of the economy.

“Inflation remains the single largest near-term challenge to the economy,” said Jim Baird, chief investment officer at Plante Moran Financial Advisors. “Although price pressures are expected to ease as the year progresses, inflation will remain above the Fed’s 2% target for some time to come.”

So the Fed has radically changed course. Last month, the central bank signaled that it will begin a series of rate hikes in March. By doing so, the Fed is moving away from the super-low rates that helped revive the economy from 2020’s devastating pandemic recession but that also helped fuel surging consumer prices.

WHAT’S CAUSED THE

SPIKE IN INFLATION?

Good news — mostly. When the pandemic paralyzed the economy in the spring of 2020 and lockdowns kicked in, businesses closed or cut hours and consumers stayed home as a health precaution, employers slashed a breathtaking 22 million jobs. Economic output plunged at a record-shattering 31% annual rate in 2020’s April-June quarter.

Everyone braced for more misery. Companies cut investment and postponed restocking. A brutal recession ensued.

But instead of sinking into a prolonged downturn, the economy staged an unexpectedly rousing recovery, fueled by vast infusions of government aid and emergency intervention by the Fed, which slashed interest rates, among other things. By spring of last year, the rollout of vaccines had emboldened consumers to return to restaurants, bars, shops and airports.

Suddenly, businesses had to scramble to meet demand. They couldn’t hire fast enough to fill job openings — a near record

10.9 million in December — or buy enough supplies to meet orders. As business roared back, ports and freight yards couldn’t handle the traffic. Global supply chains became seized up.

With demand up and supplies down, costs rose. And companies found that they could pass along those higher costs in the form of higher prices to consumers, many of whom had managed to sock away a ton of savings during the pandemic.

But critics, including former Treasury Secretary Lawrence Summers, blamed in part President Joe Biden’s $1.9 trillion coronavirus relief package, with its $1,400 checks to most households, for overheating an economy that was already sizzling on its own.

The Fed and the federal government had feared an agonizingly slow recovery like the one that followed the Great Recession of 2007-2009.

HOW LONG WILL IT LAST?

Elevated consumer price inflation will likely endure as long as companies struggle to keep up with consumers’ demand for goods and services. A recovering job market — employers added a record 6.7 million jobs last year and tacked on 467,000 more in January — means that many Americans can continue to splurge on everything from lawn furniture to electronics.

Many economists foresee inflation staying well above the Fed’s 2% target this year. But relief from higher prices might be coming. Jammed-up supply chains are beginning to show some signs of improvement, at least in some industries. The Fed’s sharp pivot away from easy-money policies toward a more hawkish, anti-inflationary policy could slow the economy and reduce consumer demand. There will be no repeat of last year’s COVID relief checks from Washington.

Inflation itself is eating into household purchasing power and might force some consumers to shave back spending.

Omicron or other COVID variants could cloud the outlook, either by causing outbreaks that force factories and ports to close and disrupt supply chains even more or by keeping people home and reducing demand for goods.

“It’s not going to be an easy climb down,” said Sarah House, senior economist at Wells Fargo. “We’re expecting CPI to still be roughly 4% at the end of this year. That’s still well above what the Fed would like it to be and, of course, well above what consumers are used to seeing.”

HOW ARE HIGHER PRICES AFFECTING CONSUMERS?

A strong job market is boosting wages, though not enough to compensate for higher prices. The Labor Department says that hourly earnings for all private-sector employees fell 1.7% last month from a year earlier after accounting for higher consumer prices. But there are exceptions: After-inflation wages were up more than 10% for hotel workers and more than 7% for restaurant and bar employees in December from a year earlier.

Partisan politics also colors the way Americans view the inflation threat. With a Democrat in the White House, Republicans were nearly three times as likely as Democrats (45% versus 16%) to say that inflation is having a negative effect last month on their personal finances, according to a University of Michigan survey.

Biden’s focus

Unable to tame inflation that has worsened sharply under his watch, President Joe Biden stressed Thursday that his administration’s policies would cut prescription drug prices and make life more affordable for families.

His pitch, which he delivered at a community college in Culpeper, Vir­ginia, came on the heels of a dire inflation report released earlier in the day.

Inflation poses a triple threat for Biden going into this year’s midterm elections. Prices at a 40-year peak have dimmed his public support and endangered his policy agenda, while efforts by the Federal Reserve to curb inflation could meaningfully slow the strong economic growth that had been a highlight of his first year.

“Inflation is up. It’s up.” Biden said. “But the fact is that if we’re able to do the things I’m talking about, it will bring down the cost for average families.”

The president said he will “work like the devil” to bring down gas prices. He said “everyone has less money in their pockets today because of high drug costs” as he pledged that his policies would give family budgets some breathing room. He said pharmaceutical companies should be able to make a profit, though they cannot price drugs at levels that hurt people’s financial wellbeing.

Joshua Davis, a 12-year-old with diabetes, introduced Biden to the crowd. Davis’ father also has diabetes, and the family’s insulin budget, even though it has insurance, runs between $6,000 and $7,000 per year. Sometimes, the family uses expired insulin to save money.

“I’m thankful that insulin was invented because it is my life support — I don’t have a choice whether or not to use it,” the seventh grader said.

— The Associated Press