You may have heard inflation has been rising in recent months as the economy rebounds from the effects of the COVID-19 pandemic. Should you be worried? The answer is an unequivocal yes, no, or maybe!
Seriously, inflation is always a concern for economists, because if prices rise broadly in a rapid fashion, it in essence steals money from the wallets of consumers. A small amount of inflation is considered part of a healthy economy, because it encourages wage growth and innovation.
Here is a 30-second lesson in economic policy: the United States established the Federal Reserve System to act as country’s central bank. You may have heard news stories about “the Fed” raising or lowering interest rates – that is the nickname of the Federal Reserve. The Federal Open Market Committee, a 12-member board, sets U.S. monetary policy per its mandate from Congress: to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy.
In general, when economic conditions are strong – for example, in the several years prior to March 2020, when the pandemic forced stay-at-home orders that shuttered many businesses – the Fed tends to raise what is known as the federal funds rate; thereby making borrowing more costly to keep the economy from overheating. Conversely, when a slowdown hits (as it did in 2008 and in 2020), the Fed lowers the federal funds rate to promote low-cost loans and boost the economy.
One of the many factors the Fed considers at its eight scheduled meetings each year is inflation.
For years the Fed has said it believes 2% inflation each year is a Goldilocks number – not too high, not too low, but just right! When the economy shut down in 2020, inflation all but disappeared because many prices dropped. However, as the world has emerged from its 14-month hibernation, prices have increased, and dramatically so in some cases.
According to the most recent report by the U.S. Bureau of Labor Statistics, over the last 12 months ending in May, inflation was up 5% before seasonal adjustment. Inflation has been going up each month since January, but the May figure worried some economists because it was the largest 12-month increase since a 5.4-percent increase in 2008. Specifically, the construction industry saw a dramatic rise in the cost of lumber and other raw materials needed to build houses. Automobile prices also are up sharply.
So should you be worried? Many economists have pointed out some price increases in 2021 are due to sharply lower prices in 2020 (For example, airline tickets). Also, several price increases are due to supply shortages and bottlenecks as dormant industries have come back to life. They expect these issues to be resolved and prices to moderate by the end of 2021 or early in 2022. The Fed released a statement in June saying because inflation has been less than 2% for years, it will allow inflation of more than 2% for “some time” before it raises rates. Something to keep an eye on, but no need for panic.