Prices have spiked over the past year in virtually every major category of consumer spending. News reports have focused on large items such as gasoline (up 50 percent) and used vehicles (up 38 percent).
But the recent price report shows inflation is pervasive: Food is up 6.3 percent, topped by a 12.5 percent hike in meat and poultry prices. Furniture and bedding is up 13.8 percent while clothing has increased by 5.8 percent. Going on vacation? The price of hotels and motels is up 27.6 percent and rental cars are up 36 percent. Moving? That rental van will be 9.2 percent more expensive than a year ago. Staying home? It costs 6.3 percent more to turn on your lights than it did a year ago. Prices are rising fast no matter what you do.
Unlike in the summer, experts now think this level of inflation is here to stay for a while. Federal Reserve Chair Jerome H. Powell told the Senate this week that he envisions the central bank raising interest rates early this year to stem inflation, something he ruled out last year when prices first started to rise. Last year, Americans were told inflation was temporary — a factor of seasonal fluctuations, statistical glitches arising from last spring’s lockdowns, and supply-chain difficulties. But Powell is finally acknowledging the truth: “What we have now,” he said, “is a mismatch between demand and supply.”
Of course we do. Demand is high because Americans have more money to spend than ever before. People of all income levels built up savings during the pandemic, amounting to $2.7 trillion. They banked this money because the federal government handed it out willy-nilly through multiple rounds of stimulus checks to everyone below a certain income level whether they were hurting or not. The recently expired expanded child tax credit pumped money directly to consumers, too. The result: record-high consumer spending despite employment still below pre-pandemic levels.
It’s worth looking more closely at that spending to appreciate what we are experiencing. The Federal Reserve Bank of St. Louis reports that Americans spent at an annual rate of $16.4 trillion in November 2021, up from $14.8 trillion in February 2020 right before the pandemic hit. That’s a $1.6 trillion increase in less than two years. It took more than two and a half years for consumer spending to increase by that amount before the pandemic. Moreover, consumers have hiked their spending by roughly $1 trillion since March, the fastest spending hike by that amount on record. It took 21 months for the economy to add that much spending just prior to the pandemic. No wonder supply chains are struggling to keep up.
Americans are nowhere close to spending down the $2.7 trillion in excess savings. Even though bank account levels are dropping, households still hold roughly $3.5 trillion in cash and checkable deposits. That’s more than $1 trillion above the high reached during the Great Recession and about $2 trillion above the highest level at any other time in the past 20 years. If consumers follow past patterns, this amount will drop as people know they can afford more for things they want. More inflation will follow.
There are only two ways for this to end. The first is to stop pumping money into the economy. Inflation soared at the end of World War II as rationing ended and Americans spent the money they had saved during the war. But the war’s end also meant the federal spigot was no longer running, and inflation dropped again once the initial savings-fueled burst ended. This means Sen. Joe Manchin III (D-W.Va.) is right; the country cannot afford to pass the Build Back Better Act or other costly measures that would add more fuel to the overheated economy.
The second is to constrain consumer spending by raising interest rates. This makes holding cash more attractive and dampens demand. But it also slows economic activity. Done too strenuously, it can throw an economy into recession. That fear has kept the Fed from raising rates thus far, leading to the state we are in now.
America went through over a decade of high inflation until President Ronald Reagan and his Federal Reserve chair, Paul Volcker, together decided to risk a steep recession to bake it out of the economy. Their gamble worked, resulting in 40 years of relative price stability and massive global economic growth. Now, the Fed and Congress must act in concert to keep inflation from spiraling out of control. If they don’t, future policymakers will have to step in, and the consequences will be harsh.