Inflation refers to the rate at which the average price of goods and services increases over time. In addition to being an indicator of rising costs, it is also an indicator of the diminishing value of money. Consider having $100 for groceries today; if inflation occurs and devalues that bill, you’ll be able to purchase fewer goods with the same amount in future. In urban areas, prices have risen to a point where nobody working 40–45 hours/week at the federal minimum wage of $7.25/hour can afford a one-bedroom apartment anymore.
To measure inflation economists use the consumer price index (CPI). This measures price changes over time, across a basket of goods which includes major expense categories like food and beverages, housing, and transportation.
Between January 2021 and September 2022, the United States CPI averaged an annual rate of 6.2%. Transportation experienced the highest inflation at 16.3%, followed by food and beverages at 6.2% and housing, including utilities and operations, at 4.8%. In May 2022, the US Department of Labor reported that inflation was 8.6% — the highest in 40 years.
This persistent inflation struck during the COVID-19 pandemic. COVID triggered inflation through a confluence of factors, including supply chain disruptions, rising consumer demand, government stimulus spending, and fluctuations in energy and transportation costs. Factory and port closures due to social distancing measures led to shortages and price hikes, while post-lockdown eagerness to spend hiked up demand for goods and services, particularly those in short supply, creating further inflationary pressure. Massive economic injections by governments around the world, though necessary to avert collapse, further fueled inflation by increasing money in circulation, while pandemic-induced energy price fluctuations increased transportation costs and heightened expenses for businesses and consumers alike.
Pandemic related pressures have now largely begun to subside. The Federal Reserve, and other central banks, have also been implementing stricter monetary policies to control inflation. In 2022, the Fed approved six interest rate hikes and planned to downsize its $9 trillion asset portfolio.
In most countries however, inflation is still above the 2% target, while in some developing countries like Pakistan, it’s higher than 30%. Why, despite all efforts, have we been unable to bring inflation under control?
The Russia-Ukraine War
The Russia-Ukraine war disrupted global supply chains, leading to an increase in the prices of essential commodities, including food and fuel. Russia and Ukraine are major suppliers of wheat and corn, accounting for almost one-third of global wheat exports. Reduced supplies of these commodities have driven up their prices. The war has also led to a decrease in the supply of oil, gas, and metals, further fuelling inflation.
The economies of countries that relied most heavily on imports from Russia and Ukraine have been most affected. According to estimates by the World Bank for instance, food inflation in Lebanon increased by 122% due to the war.
China’s Shift from Zero COVID Policy
China recently announced that it was opening up after three years of lockdowns. Given the sheer size of the Chinese market, this change in policy has global implications. Bloomberg Economics forecasted that China’s GDP growth would increase from 3% in 2022 to 5.8% in 2023, driving up global inflation by 1–2% as demand for goods and services increases. Oil prices surged from $76 to $86/barrel between December 2022 and January 2023 and delays in the manufacturing and delivery of goods to meet this increase in demand might fuel further inflation. As China rebounds, inflation in America is still well over 6%, well above the Fed’s target of 2%.
Labor Market Disruptions
Supply-side disruptions during and after COVID-19 created labor shortages that are continuing to persist. The US labor force participation rate is still 1.5% lower than it was before the pandemic, as evidenced by a fall in the unemployment rate to 3.5% and a 5% expected growth in wages. Core service prices have surged by 6.7%, the fastest pace since 1982. Labor costs make up a large portion of service costs and the Fed is concerned that inflation in services might make overall inflation more difficult to control in a timely manner.
Conclusion
All in all, it is evident that a combination of pandemic-induced factors, geopolitical events, and labor market disruptions have all contributed to the persistence of inflation. While central banks, like the Federal Reserve, have taken steps to mitigate inflationary pressures, global events like the Russia-Ukraine war and policy and economic changes in China are continuing to fuel uncertainty.
