What Is Causing High Inflation?

What Is Causing High Inflation?

Education / Business

The causes of high inflation

Federal Reserve chairman Jerome Powell responded to widespread concerns over the rapid rise of inflation on August 26th, 2022. Powell stated that “reducing inflation is likely to require a sustained period of below-trend growth” (Powell, 2022). Powell’s comment provoked a near 3% drop in US markets, as investors rushed to offload stocks in reaction to increasing interest rates and “below-trend growth” (Trading Economics, 2022). With rising inflation and the cost-of-living crisis becoming ubiquitous in the current news cycle, the rosy days of the post-lockdown economic recovery seem all the more distant.

The annual inflation rate hit a 40-year high of 9.1% in June and dropped only to 8.7% in July – significantly above last July’s 5.4% (Trading Economics, 2022). High inflation is occurring globally; the European Union interest rate was 8.9% in the European Union in July – up from 2.5% 12 months before (Trading Economics, 2022). This article investigates the factors underlying such high global inflation.

Cause #1: The specter of Covid-19 and its enduring effects on supply chains

The Covid-19 pandemic triggered widespread, prolonged lockdowns in nations around the world, which confined individuals to their homes. The lockdowns forced restaurants and stores to close and, consequently, consumer spending to decrease – such as by 9.8% in 2020 Q2 year-over-year (Lipper Alpha Insight, 2020). This reduced consumer spending led to many redundancies, while the Covid-19 illness forced some workers to take time off.

Redundancies and sick leave damaged supply chains. On a separate note, the reduced consumer spending enabled some households to save money, thus the relaxation of pandemic-related restrictions in a spending boom. Supply chains could not respond to the spending boom because the pandemic induced labor shortages at major distribution centers, depleted inventory levels, and increased raw material costs. The supply chain difficulties led to price increases for various goods as the stagnated supply could not meet the rapidly-risen post-pandemic demand. The supply chain disarray,  combined with increased consumer spending post-pandemic, is a primary driver of inflation.

5 emerging risk trends for global supply chains to watch in 2021 | DHL  Logistics of Things
Cause #2: War in Ukraine and the cost of energy and food

Russia’s Ukraine invasion on February 24th, 2022, changed the modern political landscape. Many countries rushed to sanction Russia, but Russia capitalized on its substantial oil and gas supply to pressure the European nations most reliant on Russian imports to satisfy their energy needs. Russia did this by restricting gas flow through the Nord Stream 1 pipeline to under 40% of its pre-war capacity and entirely ceasing exports to some countries. Including Poland and Bulgaria. Which drove up energy prices across Europe (DW, 2022).

European countries hurriedly divested Russian energy sources, which increased demand for alternative oil and gas sources and drove up energy prices across Western markets. Crude oil prices, representing 7.1% of the Consumer Price Index (CPI) used to calculate inflation, reached a 7-year high of approximately $120 per barrel (US Bureau of Labor Statistics, 2022). Also, crude oil prices correlate with higher transportation and plastic production costs, which further increase inflation by driving price increases in various sectors. 

The war in Ukraine also devastated the Ukrainian harvesting season. In 2021, Ukraine was the world’s largest sunflower oil exporter and the 7th largest wheat exporter. However, Russia’s invasion led to the destruction of fields and the blockade of the Azov Sea, which diminished Ukrainian exports, drove food crises, and engendered a 10% year-over-year increase in US food prices in June 2022 (U.S. Bureau of Labor Statistics, 2022). Food, energy, and shelter comprise 54% of the CPI; as a result, these food price rises have exacerbated inflation.

Ukraine-Russia War: Russia Says Not Trying To "Overthrow" Ukraine  Government: 10 Points
Cause #3: the additional effects of a tight labor market

In July 2022, the US unemployment rate was the lowest in 20+ years (along with January 2020), at 3.5% (U.S. Bureau of Labor Statistics, 2022). As the economy continues its post-pandemic recovery, employers in the manufacturing and most heavily-affected services sectors (such as restaurants and hotels) are struggling to re-staff their companies to pre-pandemic quantities. The difficulty in hiring staff forced companies to offer higher salaries and, in turn, charge higher costs for products and services to consumers. In the United States, tight labor supply has pushed the vacancy-to-unemployment rate to an all-time high. In turn causing nominal wage inflation to rise to nearly 7% YoY (Numera Analytics, 2022). Strong wage growth is amplifying inflationary pressures in labor-intensive sectors of the economy, while fueling long-term inflation expectations.

In conclusion:

Ultimately, the effects of the Covid-19 pandemic, the war in Ukraine, and the tight labor market are three of the predominant factors driving inflation to unprecedented highs. It is uncertain whether the combined effects of forecasted below-trend growth and rising interest rates will lower inflation rates in the coming months. It is unsure whether the slight year-over-year US inflation decrease between June and July indicates the stabilization of inflation. 

Oxford Lecturer & Turnleaf Analytics Co-Founder Alexander Denev told us:

“A plausible scenario is that we could observe some persistence of inflation as geopolitical pressures continue to accumulate and inflation expectations continue to be high, something that can be only partially mitigated by the observed easing of supply chain bottlenecks. Rising interest rates and demand destruction coupled with some increase of unemployment also will most certainly play out their role in the future by putting downward pressure. But by knowing from past data that inflation can be perniciously persistent, maybe we should be braced for more of it in the near future.”

What Is Causing High Inflation? Written by Sebastien Brown & Edred Opie

Nobel Prize Winning Economist. Stanford Professor Paul Romer. On Hyperinflation & Protecting Science
References:

Works Cited

Ferreira, Joana. “United States Unemployment Rate.” Tradingeconomics.com, TRADING ECONOMICS, 2022, tradingeconomics.com/united-states/unemployment-rate.

Numera Analytics. ‘The Persistent Inflation Hypothesis’. Global Macro Strategist, August 2022. https://numeraanalytics.com/wp-content/uploads/Numera-Analytics-Global-Macro-Strategist-August-2022.pdf

Powell. “Speech by Chair Powell on Monetary Policy and Price Stability.” Board of Governors of the Federal Reserve System, 2022, www.federalreserve.gov/newsevents/speech/powell20220826a.htm. Accessed 29 Aug. 2022.

U.S. Bureau of Labor Statistics. “CPI Inflation Calculator.” Bls.gov, U.S. Bureau of Labor Statistics, 2019, www.bls.gov/data/inflation_calculator.htm.

—. “U.S. Bureau of Labor Statistics.” Bls.gov, 2022, www.bls.gov/.

“U.S. Consumer Spending Preview: Q2 2020 | Seeking Alpha.” Seekingalpha.com, 2020, seekingalpha.com/article/4367881-u-s-consumer-spending-preview-q2-2020. Accessed 29 Aug. 2022.

“United States Inflation Rate – July 2022 Data – 1914-2021 Historical – August Forecast.” Tradingeconomics.com, 2022, tradingeconomics.com/united-states/inflation-cpi#:~:text=Forecasts%20at%208.5%25-. Accessed 29 Aug. 2022.Welle (www.dw.com), Deutsche. “Russian Gas Again Flowing into Europe via Nord Stream 1 Pipeline | DW | 21.07.2022.” DW.COM, 2022, www.dw.com/en/russian-gas-again-flowing-into-europe-via-nord-stream-1-pipeline/a-62545705. Accessed 29 Aug. 2022.

What Is Causing High Inflation?

Education / Business