What even is inflation, and why is it happening? - Albuquerque Journal

What even is inflation, and why is it happening?

A body technician works on a vehicle at Car Crafters in Albuquerque July 27. The auto repair shop is facing steep increases in the cost of labor, parts and freight. (Adria Malcolm/For the Journal)

What is inflation and why is it happening now?

Inflation occurs when the price of goods and services rises over time. Reilly White, associate professor at the University of New Mexico’s Anderson School of Management, said inflation is a welcome phenomenon in moderation, encouraging wage growth and discouraging money hoarding. The Federal Reserve has set 2% annual inflation as its long-term target.

When prices rise too rapidly, however, White said price growth can outstrip wage growth, eroding purchasing power and reducing consumer confidence.

“In the long run, it’s like a battle that strangles you,” White said. “You feel like you can’t win.”

White said the COVID-19 pandemic has wrought havoc on both supply and demand, contributing to rapid inflation over the past 12 months. When the pandemic began, many firms cut back production in the face of an uncertain future.

These cuts, exacerbated by tariffs and overseas disruptions to global supply chains, have temporarily reduced the supply of a wide variety of items, ranging from cars to microchips, White said.

At the same time, consumer demand, spurred in part by state and federal stimulus programs, has risen dramatically over the past 12 months. The result has been a large, if unequal, increase in prices across the economy.

“When you have low supply and high demand, prices go up,” White said.

So, how big of a concern is inflation?

The economists who spoke with the Journal generally agreed the U.S. is unlikely to see a repeat of massive levels of inflation associated with the 1970s and early 1980s, but that doesn’t mean inflation won’t be hard on plenty of Americans in the short and medium term.

Jim Peach, professor emeritus in economics at New Mexico State University, said short-term inflation tends to be hardest on poor people, who are already stretched paying for essentials like food, clothing and shelter.

“If you start raising prices without raising their wages, they’re in a world of hurt,” Peach said.

Tim Duy, chief economist at SGH Macro Advisors and economics professor at the University of Oregon, said current situation, where price growth has outstripped wage growth, is untenable and unlikely to continue in perpetuity.

“This is not a sustainable situation,” Duy said.

Duy added the biggest long-term risk is that inflation stays high enough for long enough to change people’s future expectations, which adjusts consumer behavior and helps embed high inflation in the economic system going forward.

How long that will take and what level of inflation will trigger that remains an open question, Duy said. He said inflation of 4% annually would likely create an environment where most Americans notice the effects and start managing their budgets differently.

However, he stressed that inflation will affect everyone differently and many of those effects will deviate from the norm depending what goods and services each person purchases.

“There’s only one average American,” Duy said. “For everyone else, they have to deal with the consequences of inflation on their own budget.”

What industries have been most affected?

UNM’s White said a typical New Mexican is most likely to see evidence of inflation when filling up their car or buying a new one.

White said New Mexico’s large size and reliance on agriculture and extractive industries mean that residents drive a lot — with the fourth-most vehicle miles traveled in 2018, according to the Federal Highway Administration — and are more susceptible than most to automotive changes.

NMSU’s Peach said the rising prices have squeezed profits in the oil and gas industry, prompting them to raise prices in return. Like many industries, Peach said the oil and gas industry cut supply last year due to volatility, and the New Mexico rig count remained about 35% below its pre-recession high earlier this summer.

White added that used cars have spiked in price as well. The Manheim Used Vehicle Value Index, which tracks the price of preowned vehicles, was up 23.6% compared to last July.

“This is an unheard of thing,” White said. “We don’t have records that show something this specific.”

White said a lot of companies got rid of their car fleets or rental cars at the start of the pandemic. When people began shopping for cars again, they quickly shot up in price. White added that new car production, hampered by microchip shortages, hasn’t recovered quickly enough to offset the impact.

White and Peach agreed that the impact of inflation has touched a number of sectors, from residential construction to leisure and hospitality.

What will the Federal Reserve do?

The Federal Reserve – America’s central banking system, charged with maximizing employment and stabilizing prices, among other mandates – has a few tools for reducing inflation, including scaling back asset purchases and raising the interest rate on overnight lending to large banks. So far, however, it has been reluctant to do so, out of fear of stunting the nation’s still-vulnerable economic recovery.

Duy, who ran a long-running blog dedicated to monitoring the Federal Reserve, said the central bank recently tweaked its policies to rely less on inflation forecasts and more on actual outcomes. Consistent with that new approach, Duy said the Fed’s board has so far been comfortable holding inflation modestly above its 2% target.

“Despite the inflation numbers that we’ve seen, they haven’t reacted to those numbers just yet,” Duy said.

Duy added that he doesn’t expect the Fed to start seriously looking at tapering its purchases of mortgage-backed securities and other bonds, which have remained at $120 billion per month since December, until later this year at the earliest. Any uptick in the lending rate will likely not occur until late 2022 or even early 2023, Duy said.

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