How inflation can hurt and help consumers, economists say
A person shops on March 10, 2022 in the Prospect Lefferts Garden neighborhood of Brooklyn.
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Inflation hit a new 40-year high in June, and policymakers are working feverishly to tame it, perhaps even risking recession to do so.
Jerome Powell, chairman of the Federal Reserve, said in June that price stability was “the foundation of the economy.” The central bank is raising borrowing costs sharply to dampen consumer demand and limit price increases.
“The worst mistake we could make would be to fail, which is not an option,” Powell said. said.
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Senator Joe Manchin, a centrist Democrat from West Virginia, said Wednesday that inflation “presents a clear and present danger to our economy.”
But while the specter of persistently high inflation can scare policymakers and consumers alike, experts point out that, under certain circumstances, some consumers could benefit from inflation. More broadly, some inflation is actually good for the economy. Let’s see how the problem breaks down, with a focus on the impact on consumers.
The big problem with inflation: “People are getting poorer”
One of the main concerns regarding the persistence of high inflation is the decline in the standard of living of Americans.
Inflation measures how quickly the prices of goods and services such as gasoline, food, clothing, rent, travel, and health care rise. The consumer price index, which measures the price changes of a wide basket of items, jumped 9.1% in June from a year earlier, the biggest annual increase since November 1981.
These prices do not exist in a vacuum, however. Household income may also increase, through wage increases for workers and cost-of-living adjustments for retirees, for example.
In theory, if a person’s income increases faster than prices, their standard of living improves. In this scenario, their so-called “real wages” (wages after accounting for inflation) increase.
Here’s the problem: Inflation is outpacing historically strong wage growth.
Private sector workers saw their hourly wages after inflation drop 3.6% from June 2021 to June 2022, according to the US Bureau of Labor Statistics. This is the biggest drop since at least 2007, when the agency began tracking Data.
Senior citizens and others living on fixed or static incomes may be particularly hard hit by runaway inflation, economists say.
“The obvious downside of what’s happening right now – which is largely, but not exclusively, related to commodity prices [like oil] — is that people are getting poorer,” according to Alex Arnon, associate director of policy analysis for the Penn Wharton Budget Model, a research arm of the University of Pennsylvania. “And they will probably live less pleasant lives.
This dynamic can have knock-on effects. From a behavioral perspective, consumers can change what they buy to help cover costs. An outright pullback can fuel a recession, as consumer spending drives the US economy. Personal consumption accounts for about 70% of gross domestic product.
While average household wages have fallen over the past year due to inflation, some Americans may still stand out when considering their total wealth, according to Wendy Edelberg, senior economics researcher at Brookings. Institution.
Edelberg, former chief economist for the Congressional Budget Office, cited “the extraordinary increases in real estate prices” as an example.
About two-thirds of Americans own a home. The value of a typical home sold in May by existing owners topped $400,000 for the first time and was up nearly 15% from a year ago, according to the National Association of Realtors. (However, there are signs that the housing market may be cooling.)
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And some groups come out ahead in an inflationary environment.
For example, some have seen dramatic wage increases that outpace inflation. Core workers in leisure and hospitality, which includes restaurants, bars and hotels, saw their hourly earnings rise 10.2% in the year to June, department data shows. US Labor – about 1 percentage point above the rate of inflation. (Of course, just because their wage growth is outpacing inflation doesn’t mean these workers are necessarily earning a living wage. The non-middle-manager earned $17.79 an hour in June.)
According to Loyola Marymount economics professor James Devine, consumers with fixed-rate mortgages and other loans that don’t fluctuate with prevailing interest rates may have an easier time paying off those pre-existing debts, especially if their wages greatly exceed the rise in prices. University.
“On the one hand people gain from inflation (as debtors) but on the other hand they lose if their money wages are below inflation (as wage earners),” Devine said in a E-mail.
Typically, it takes ordinary people a year or more to raise their salaries and catch up with prices, Devine said.
Then there’s hyperinflation: a rare and “disastrous” scenario in which inflation jumps 1,000% or more in a year, according to the International Monetary Fund. In 2008, Zimbabwe experienced one of the worst episodes of hyperinflation, which was at one point estimated at 500 billion percent, for example, according at the IMF.
At these extremes, prices for bread, for example, could start and end the day at different levels – a dynamic that could lead to hoarding of perishables and shortages that push prices even higher. The value of a country’s currency can drop significantly, making imports from other countries extremely expensive.
Zimbabweans queue to withdraw cash from a bank on June 21, 2008 in Bulawayo, Zimbabwe.
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Savings are swallowed up as the value of money erodes, ultimately leading to less investment, reduced productivity and stalled economic growth – a recipe for chronic recession if not contained, said Brian Bethune, an economist and professor at Boston College, of the potential consequences.
To be clear: the United States is not close to that.
“We’re not there yet,” according to Edelberg. “We’re not all going to buy rice because we think rice is a better store of value than dollars.”
However, some fear that the Federal Reserve could inadvertently tip the United States into a recession by raising its benchmark interest rate to reduce inflation. It’s not a foregone conclusion; a slowdown, if it occurred, would be accompanied by job losses and financial difficulties.
At the other end of the spectrum, there is deflation – a falling price environment, which is also undesirable.
For example, consumers may delay purchases if they expect to pay a lower price in the future, thereby reducing economic activity and growth, according to the International Monetary Fund.
Companies should probably give pay cuts to staff – something workers hate, even if their lower incomes can buy the same amount of stuff (which also goes down in value), economists said.
Consumer inflation expectations are ‘absolutely essential’
Which is to say: policy makers generally see some inflation as a good thing for the economy.
The key is that it’s low and stable enough that people don’t notice it – hence the Federal Reserve’s target rate of around 2% over the long term. (The central bank preferred measure of inflation, the personal consumption expenditure price index, is a little different from the consumer price index.)
Low and stable inflation helps keep consumer expectations in check. If consumers anticipate persistently high inflation—even if those expectations are disconnected from reality—these whims can become a self-fulfilling prophecy.
For example, there is the notion of a “wage-price spiral”, in which workers demand higher increases to keep up with what they expect to be entrenched inflation. Firms raise prices for consumers to offset higher labor costs, which can become a vicious cycle, economists say.
In this type of environment, banks could also increase borrowing costs for a loan, assuming inflation (and interest rates) remain high. However, if inflation and prevailing interest rates drop and borrowers can’t refinance a fixed loan, they will be “hammered” when they have to repay that money, Edelberg said.
While consumers expect prices to rise in the near term (over the next year), their medium- and long-term (three and five-year) inflation expectations fell in May, according to a Federal Reserve Bank of New York. investigation released on Monday.
New York Fed researchers see this as a good sign. The data suggests that inflation expectations have yet to take root, meaning the dynamics of a wage-price spiral and self-fulfilling prophecy do not appear to be present, the researchers said.
Fed Chairman Powell recently echoed that sentiment.
“We think the public generally sees us as very likely to be successful in bringing inflation down to 2%, and that’s critical,” he said in June. “It’s absolutely critical to all of this that we maintain that trust.”