Economic Update: With prices surging due to inflation, a paycheck isn’t going as far as it used to

Posted on June 14, 2021 by Chris Chmura

This article was originally published in the Richmond Times Dispatch on June 13th, 2021. 

Rising prices due to new inflation

Gasoline prices in the Richmond region and beyond have been increasing in recent months with prices rising more than $1 per gallon than a year ago.

The average price of a gallon of regular gas in the Richmond area on June 9 was $2.94, up 20 cents from a month ago, according to motorist club AAA Mid-Atlantic.

Area drivers were paying about 64% more - or $1.15 higher - than the average of $1.79 a gallon a year ago at this time.

That means it costs $23 more to fill up a 20-gallon tank of gas than it did a year ago.

That can take a chunk out of the budget over the course of a year if such price increases continue. Economists say it is like a tax increase because it’s money that you no longer have to spend on eating out or purchasing clothing.

And it’s not only gas prices that are increasing.

The price of used cars and trucks rose 29.7% in the 12 months ending with May, according to the Bureau of Labor Statistics.

Major appliances jumped 12.3%, bacon rose 13.0%, and airline fares increased 24.1% over the same period.

This increase in price - or inflation - is something that many people in today's workforce haven’t experienced because the U.S. has been in a low-inflation environment for more than two decades.

There are a couple of indicators that the government uses to measure inflation.

The most widely referenced is the consumer price index, or CPI, that tracks the cost of a basket of goods and services that are typically purchased by consumers.

The CPI rose 5% in May after rising 4.2% in April when compared to a year ago. That’s much higher than the 2% per year that economists believe promotes healthy growth.

Changes in consumer behavior

Aside from the fact that rapid inflation eats away at consumer spending power, it is important because it causes consumers and businesses to change their behavior.

For example, the price of steel was rising rapidly in 2008 at the beginning of the Great Recession. It started that year at 20% compared with the prior 12 months and peaked at a 93.9% year-over-year pace in August 2008 because of strong demand for new office space and durable goods that contained steel.

With steel prices rising so quickly, some builders and manufacturers probably purchased more steel than they expected to need over the next few months or year to save money on the expectation that prices would continue to rise.

However, the recession soon caused a sharp drop in demand for many items. So, the businesses that had purchased more steel than they needed now had a large inventory.

When the recession ended and demand picked back up, these businesses did not need to purchase more steel until they worked off their inventory. As a result, steel prices and demand remained depressed longer.

This is an example of why rapid inflation is bad for the economy — it can cause recessions to be deeper and longer than in an economy when inflation is low.

For this reason, the Federal Reserve Board typically raises the federal funds rate target when inflation is accelerating above 2% or so to slow down economic growth and inflation.

But the Federal Reserve is not raising interest rates now because they believe the recent spike in inflation is temporary.

They argue, in part, that with the economy opening after the pandemic, strong demand for goods and services has surged much faster than the supply can come online.

But with about 9.3 million unemployed as of May, the economy is not approaching its capacity to produce more goods and services. In the meantime, businesses can raise prices.

Other observers argue that supply will remain tight well into 2022 because of worker shortages resulting from low labor force participation. The labor force participation rate was little changed at 61.6% in May and has remained within a narrow range of 61.4% to 61.7% since June 2020—the lowest it has been since the 1970s.

Without policy interventions, those shortages will drive prices up further.

Such a trend would be a rude awakening for workers who have gotten used to getting a 2% or 3% pay increase but all of a sudden see their spending of essential items rise by nearly 10%.

This blog reflects Chmura staff assessments and opinions with the information available at the time the blog was written.