The three forces driving inflation higher and what it will take to cool them off

And while consumers across the economic spectrum are feeling the pinch, accelerated inflation tends to squeeze low- and fixed-income earners the most. Richard Curtin, director of the University of Michigan’s Consumer Sentiment surveys, says his data shows that the “pain” of inflation has touched every corner of the US economy.

“You have to eat, you have to drive to work and take the kids to school, and you have to live somewhere. These aren’t discretionary areas,” Curtin said, adding that consumers are looking for other places where they have room to cut their expenses.

“It’s painful,” he said.

Experts say there are three main factors currently fueling much of the price growth: sharply rising labor costs, energy prices and interest rates. Each one pushes the cost of everyday consumer goods higher, and it will take a complex set of forces to return to pre-pandemic normal.

Rising wages

The legion of workers leaving their jobs, especially those in low-wage sectors, has played an enormous role in the rising cost of labor, said Jayson Lusk, a professor and the head of agricultural economics at Purdue University.

“To get enough workers to show up now, you need to pay more, so we’re seeing rising wage rates throughout many food and agricultural sectors,” Lusk said.

Lusk cited the wages now being paid to meat processors, which according to BLS data have climbed 8.3 percent from the third quarter of 2020 and the third quarter of 2021, as an example of accelerating wage growth in the food industry.

Overall, BLS data show, US employment costs have accelerated in three of the last six quarters, and at levels well above pre-pandemic trends. Economists had expected a waning pandemic and relaxed Covid-era restrictions to prompt the return of more workers to the labor force, but that is not happening as fast as anticipated, Lusk said.

“The labor market needs to get sorted out; you need a solution to the Great Resignation problem,” he said. “There’s no normalcy until that occurs.”

The timeline for that is anything but clear, however. Respondents to a November 2021 survey by the Federal Reserve Bank of Philadelphia said they generally expect payroll growth to remain high in 2022.

“If these forecasts are correct, the job openings and quits rates are likely to remain elevated and wage growth is likely to remain strong for the rest of the year,” according to Bart Hobijn at the Federal Reserve Bank of San Francisco, who wrote the bank’s economic letter this month.

Energy cost conundrum

After workers manufacture the products, the goods must be transported. So while you’re at the pump paying high gas prices, that means the companies trucking your packages and groceries are doing the same.

The average price for a gallon of gasoline in the US is hovering around $4.10, and the price of crude oil, which can affect how much money you spend at the pump, has repeatedly climbed past $100 per barrel in recent months. The benchmark Brent crude averaged $117 a barrel in March, a $20 increase from February. The US Energy Information Administration said in its most recent outlook that the increase was sparked by Russia’s invasion of Ukraine, which has roiled markets worldwide.

“Sanctions on Russia and other actions contributed to falling oil production in Russia and created significant market uncertainties about the potential for further oil supply disruptions,” the EIA said, adding that this was occurring against a backdrop of already low oil inventories and higher demand.

“Actual price outcomes will depend on the degree to which existing sanctions imposed on Russia, any potential future sanctions, and independent corporate actions affect Russia’s oil production or the sale of Russia’s oil in the global market,” the EIA said.

Cooling off demand

The ultimate driver of consumer prices is simply demand. At the onset of the pandemic, the US government unleashed waves of supportive financial measures to fortify the economy as businesses shut down.

But Lusk, the Purdue economist, conceded that however necessary those measures were in the short run, they may have led to the excess demand the Federal Reserve is now trying to cool off.

“People have money, and they’re wanting to spend it,” Lusk said. “And despite higher prices, if you ask how people are responding to inflation, they’re saying, ‘I’m not really changing, I’m just paying more, not cutting back.’ That suggests they’re not acting like it’s a recessionary environment yet.”

It’s the main reason the Federal Reserve is now poised to raise interest rates by 0.5 percent at its next meeting the first week of May, with plans for six more rate hikes through the end of 2022. The idea is to make it more expensive to borrow and invest money.

“Forecasters widely underestimated the severity and persistence of supply-side frictions, which, when combined with strong demand, especially for durable goods, produced surprisingly high inflation,” Federal Reserve Chairman Jerome Powell said in a March 21 speech, confirming that there has simply been more in demand for fewer available goods, which has led to higher prices.

Powell said the Fed will use its tools “to moderate demand growth, thereby facilitating continued, sustainable increases in employment and wages.”

At least one economist believes the inflation numbers for March could be the peak with a gradual decline to follow. Ian Shepherdson, chief economist at Pantheon Macroeconomics, now forecasts 6 percent inflation by July — and 3 percent by next January.

“The forecasts are contingent on oil prices remaining close to their current level, and core inflation easing on the back of falling vehicle prices and slowing wage gains,” he wrote in a note to clients on April 12.