Why Is Inflation So High?

Prices rose faster than your income in 2022, and your dollars are buying less than before. The cost of gas, milk, beef, chicken, hotels, airline tickets, used cars, new cars, etc., is higher. The latest Consumer Price Index (CPI) reading came in at 5.6%, an improvement from the worst months but still high. Inflation was an inescapable fact of life in 2022, and it is still taking a bite out of your wallet, making it trickier to balance budgets.

Moreover, inflation is affecting stock market returns as companies report lower profitability. Inflation also makes investing and retirement planning difficult because your dollar does not go as far as it used to. In fact, in 2022, inflation was near a 40-year high after years of modest inflation of approximately 2% to 3%. The United States Bureau of Labor Statistics indicates that the Consumer Price Index (CPI) peaked in summer 2022. Applying the Rule of 72, money depreciates in half in 36 years at 2% inflation, but only nine years at 8% inflation, reducing your buying power.

The last time inflation was this bad was in the early 1980s. Although has tapered some, it is still elevated. But many of us don’t understand why inflation is near a 40-year high. Today, here are the reasons why prices keep increasing.

Why Is Inflation So High?

Supply Chain Disruptions

The worst months of the COVID-19 pandemic are behind us. However, it disrupted almost all business operations in multiple ways, and the effect is still present. First, companies experienced a significant reduction in demand because consumers were not buying goods and services. It was not a surprise because millions lost their job, and the unemployment rate soared to almost 15%, the highest on record. As normal demand patterns changed, companies cut orders to their suppliers, disrupting the supply chain, especially when combined with employees calling in sick.

With more people at home, demand for items like paper products, flour, dairy, frozen food, electronics, etc., rose quickly. As a result, producers could not meet consumer needs, and prices started to rise. Alternatively, the retail price stayed the same, but sizes and quantities became smaller, i.e., shrinkflation.

However, as the unemployment rate dropped and demand started to rebound, companies did not have enough supply to meet demand. Moreover, big-ticket and expensive items like cars, electronics, RVs, etc., must be planned in advance by manufacturers to order long lead-time input materials and change tooling and processes. Consequently, prices started to rise.

Moreover, China remains an uncertain factor in the global supply chain. The country manufactures a large percentage of electronics, consumer goods, fasteners, etc. But the government has locked down entire cities because of COVID-19 restrictions. Companies utilizing China as their manufacturing hub are severely impacted. For instance, Apple is now attempting to move manufacturing to India and Vietnam. But China’s lockdowns and resulting supply chain disruptions likely limit supply and contribute to high inflation.

Labor Shortages 

In the US, labor shortages are hindering production for small businesses, manufacturers, farms, etc. Unemployment is sub-4%, and jobs are plentiful and easy to find. The United States had 21 months of job growth. Additionally, companies have reported people retiring early or leaving for new jobs. When companies and small businesses have difficulty filling positions, production and output suffer. Also, they must pay higher wages for labor that are passed to customers. Hence, rising wages are contributing to high inflation.

Drought

One wild card in rising inflation is drought. Globally, drought has been a significant problem, and 2022 worsened it. In the United States, many large agricultural states are experiencing prolonged droughts. Furthermore, parts of China, Europe, and Africa are experiencing their worst drought in decades. As a result, drought has reduced agricultural production by farmers.

Similarly, ranchers have reduced the output of livestock. The result is rising prices for grain, cereals, dairy, and meat, as experienced by many people in grocery stores. In some regions, drought will not end soon, and prices will probably stay elevated.

The Russo-Ukrainian War

The second wild card was the unexpected expansion of the Russo-Ukrainian War. Ukraine exports a significant amount of grain and oilseeds. Lower exports have caused skyrocketing food prices around the world. Russia is also a major wheat exporter, and sanctions are limiting its exports, helping prices rise. Lastly, expansion of the Russo-Ukrainian War caused global oil, natural gas, and auto fuel prices to spike. Rising energy costs are a leading contributor to inflation.

Federal and Monetary Stimulus

The federal government has provided significant stimulus to state and local governments, businesses, and Americans. Bills like the Coronavirus Aid, Relief, and Economic Security Act, known as the CARES Act in 2020; the American Rescue Plan Act in 2021; and supplemental bills pumped trillions of dollars into the US economy. This money arguably limited deeper unemployment and state and local problems, but it drove up demand as it put money in the hand of consumers. However, manufacturers and retailers could not meet the need quickly, causing prices and inflation to rise.

Simultaneously, the US Federal Reserve lowered the Federal Funds Rate to a rate of 0% to 0.25% and the discount rate to 0.25%. But they did not stop there. Instead, the Fed implemented an array of programs with one goal: to increase liquidity and stimulus. 

The combination of fiscal and monetary stimulus caused demand to rise and drove inflation. Borrowers with access to cheap money started buying cars, electronics, real estate, furniture, etc., increasing demand and prices. Fiscal stimulus has ended, and the Fed is attempting to remove monetary stimulus, but like a large ship with momentum, it takes time to change course.

Why Is Inflation So High – The Reasons Are Complex

High inflation has made life difficult for consumers because budgets must be stretched further each month. Businesses are struggling too with higher costs. Inflation causes money to depreciate faster. Also, investors are challenged with poor stock market returns and greater volatility. Rising inflation is a consequence of several factors coming together at one time. Take any single one out, and inflation may be less. That said, the conditions allowing low inflation at about 2% to 3% annually are absent now. Rising prices may be with us through the rest of 2023 and into 2024.

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