WASHINGTON (AP) — What’s keeping inflation so high? The answer, it seems, is almost everything.
Supply chain grunts and parts shortages inflated the cost of factory goods when the economy surged out of the pandemic recession two years ago. Then it was an increase in consumer spending fueled by federal stimulus checks. Then, Russia’s invasion of Ukraine disrupted gas and food supplies and sent those prices skyrocketing.
Since March, the Federal Reserve has been aggressively raising interest rates in an attempt to quell the price spikes. So far, there are few signs of progress. Thursday’s September consumer price report was warmer than expected, even as some of the main drivers of inflation – gasoline prices, used cars – fell for a third consecutive month.
LOOK: Inflation remains stubbornly high despite Federal Reserve efforts to stabilize costs
Consumer prices, excluding volatile food and energy costs, soared 6.6% from a year ago – the fastest pace in four decades. Headline inflation fell slightly, mainly due to cheaper gasoline. But more expensive food, medical care and housing indicated widening price pressures across the economy.
High inflation has now spread far beyond physical goods to the country’s vast service sector, which includes everything from dental care and apartment rents to car repairs and hotel rates. Widening inflation makes it more difficult to control. Thursday’s report pointed out that the Fed may need to raise its short-term policy rate even higher than expected – and hold it longer – to rein in inflation.
Such action would mean even higher loan rates for consumers and businesses. It could also cause recessions in the United States and global economies, international finance officials warn. Higher U.S. rates encourage investors to withdraw money from foreign markets and invest it in U.S. assets for a higher return, a shift that can cause upheaval in foreign economies.
Here’s what’s causing persistent inflation and what it means:
Spending still holds up – for some
Consumers as a whole are still managing to spend more, even though average wage gains over the past year have not kept up with inflation. Many companies, especially large corporations, have taken advantage of rising wages and increased consumer savings from government stimulus checks to raise their prices.
PepsiCo, for example, said Wednesday that while volume purchases fell 1% in the third quarter of the year, it was able to raise prices by 17% without losing customers.
“We obviously came out of the third quarter with the consumer still very healthy in terms of our particular categories,” the company’s chief financial officer, Hugh Johnston, told investors.
READ MORE: As rent and food prices rise, retail sales held steady in September
Yet for many Americans, lower wages (after adjusting for inflation) could eventually dampen demand and help companies lower prices.
There are already signs that some Americans, especially low-income families, are balking at inflated prices. Used car sales plummeted over the summer. A major car dealership, the CarMax chain, blamed “vehicle affordability issues that stem from widespread inflationary pressures, as well as rising interest rates” for the drop.
Meanwhile, Jonathan Smoke, chief economist at Cox Automotive, said many high-income consumers entered the used-car market, at least making up for some of the loss to previous buyers.
“We’re seeing an increase in the number of higher-income households buying used vehicles,” Smoke said. “The profile of those who buy second-hand is an extremely high-end type of customer.”
Services inflation takes over
Rising prices can often lead consumers to redirect their spending to other things, rather than reducing it overall. Right now, for example, Americans are shifting more of their spending from physical goods to services. And this change is evident in categories where prices are increasing.
“Most people in America spend pretty much their entire budget anyway,” said Eric Swanson, an economics professor at the University of California, Irvine. “So the money is going to be spent, it’s just a matter of what it’s going to be spent on.”
In September, the price of a major service – restaurant meals – jumped 8.5% from a year earlier. This is the largest such increase in 41 years. Similarly, Delta and American Airlines are seeing strong increases in revenue as more Americans are willing to spend on travel.
LOOK: Will the increase in social security benefits be enough to offset inflation?
Yet restaurants, airlines and hotels all still have far fewer workers than before the pandemic. With healthy demand, companies in these industries have been forced to grant large wage increases to attract or retain workers. These increases are often then passed on to consumers in the form of higher prices – a cycle that fuels inflation.
Many other services are also reporting steep price increases, including health care, car insurance, veterinary services and dental visits. Vision care and eyeglasses jumped 3.2% from August to September, the largest increase ever for this category.
Home prices defy the Fed
Fed rate hikes led to significantly higher mortgage rates, which contributed to a 20% drop in home sales from a year ago. Once-hot home prices even fell in July on a monthly basis, according to the most recent data from the S&P Case-Shiller Home Price Index.
READ MORE: High mortgage rates, prices discourage buyers and cool housing market
Apartment rental costs are also starting to slow, according to real-time data from ApartmentList and Zillow.
Yet in Thursday’s inflation report, a key measure of housing costs jumped 0.8% from August to September. This is the largest monthly increase in 32 years. The discrepancy occurred because the government’s rent gauge operates with a significant lag: it tracks all rent payments – not just those on new leases – and most of them do not change from month to month. the other. Economists say it could be a year or more before the drop in new leases trickles down to government data.
Will the Fed cause a recession?
This is the biggest fear hanging over the economy. Chairman Jerome Powell and other Fed officials have said they will base their policies solely on changes in government inflation data, rather than in response to data from other sources.
Still, that poses a high-risk challenge for the central bank: will it keep raising rates, or leave them at elevated levels, if forward-looking data suggests rental costs are falling?
For now, the Fed is ready to err on the side of continuing to raise borrowing rates. According to the minutes of its last meeting in September, policymakers “stressed that the cost of taking too little action to reduce inflation likely outweighed the cost of taking too much action.”
The Fed ready to weaken the economy for “a few years”
At their last meeting in late September, Fed officials warned that their rate hikes would likely slow the economy for an extended period, with growth “at a below-trend pace over this year and the next few years. “and unemployment would likely rise.
READ MORE: Federal Reserve Chairman Jerome Powell says fighting inflation could cause a recession
Among central bank officials, Loretta Mester, president of the Federal Reserve Bank of Cleveland, issued one of the harshest notes this week when she suggested that “it will be a few years before inflation back to the Fed’s 2% target.”
“We can’t say inflation has peaked yet,” Mester said.