Everything you always wanted to know about inflation (but were afraid to ask)

Since the COVID-19 pandemic hit the world in 2020, Americans have been living in the grip of inflation—and for many people, it's still a confusing time.

As part of a series on how Americans are dealing with inflation, NPR asked listeners and readers to share some of the most important questions they still have about inflation.

Many responded and asked questions about aspects of inflation that still seem incomprehensible to them, such as whether companies take profits or whether election years affect inflation.

Here is a compilation of the six most frequently asked questions – and their answers.

Are companies just using inflation as an excuse to increase their profits?

It's complicated. Companies have faced the same higher costs that the rest of us have – and many of them have passed those costs on to consumers.

At the same time, some companies have also been able to use higher inflation as an opportunity to raise their prices more than simple cost increases would justify. This is no surprise. Companies exist to maximize their profits, and they usually charge what they think the market will bear.

“Corporate executives can use inflation to their advantage,” says Rakeen Mabud, chief economist at Groundwork Collaborative. “They can exploit things like supply chain problems to raise prices beyond what their input costs would justify.”

But there is good news. These “input costs” – the costs associated with producing a product – are falling, meaning companies no longer have to raise their prices as much.

At the same time, consumers are resisting aggressive pricing strategies, so companies are gradually backing down. McDonald's, for example, has reintroduced a $5 menu after the first drop in sales since the start of the pandemic.

How do high interest rates reduce inflation?

High interest rates help combat inflation by increasing the cost of borrowing, which in turn can slow economic activity and therefore consumer spending.

For example, someone who has to pay more on a car loan or mortgage may have less money left for other expenses.

And to combat inflation, the Federal Reserve has raised interest rates to their highest levels in over two decades.

Interest rates are at their highest level since 2001

These higher interest rates helped reduce inflation, which fell to an annual rate of 2.9 percent last month.

It's not just high interest rates that are helping to slow inflation. A key reason inflation spiked during the pandemic was that businesses weren't well prepared to meet rising demand from home-bound consumers for everything from iPhones to laptops.

But companies are now responding to the shortages of goods that have occurred during the pandemic by investing in their supply chains.

“If we get new technologies, better processes and better equipment, that can help lower the cost of producing various goods and services, and that can be passed on to the consumer,” says Sarah House, a senior economist at Wells Fargo.

Why is the target inflation rate 2% – shouldn’t it be 0%?

Setting a target inflation rate is intended to contribute to greater price stability by giving the central bank a clear objective.

New Zealand was the first country to set a target rate of 2% in 1989. Most central banks followed suit, including the Fed, which explicitly announced the target in 2012.

While an inflation rate of 0% sounds ideal in theory, economic growth requires some form of inflation.

Setting a target of 0% also increases the risk that the Fed will exceed its target and lead to negative inflation or deflation.

Then prices fall, which sounds positive but can be very damaging economically. Extensive price reductions are usually a symptom of economic distress.

What influence did election periods have on inflation?

In short: not much.

In addition, economists point out that every election year is different, so a comparison of the elections is rarely a direct comparison.

In addition, the Fed typically vehemently defends its independence in setting monetary policy – ​​regardless of whether elections are taking place.

However, sometimes elections can also lead to a decline in spending by businesses and consumers, which can help slow inflation.

“Companies and people are very uncertain about who's going to win and what the future holds. So they decide to hold back a little bit – you know, maybe not spend as much money, maybe not hire that new employee or not make that investment until they know,” says Julia Coronado, president of MacroPolicy Perspectives.

Why does it take so long for inflation to subside?

Here, ordinary citizens and economists may see things differently.

“By economists' standards, inflation is coming down really quickly, and I know that's not by the standards of the average person,” Coronado says.

Many people still feel that they pay more in the supermarket or in a restaurant than they used to – and they are not wrong.

During the pandemic, inflation has risen more than many Americans were used to in previous years, and cumulative price increases continue to weigh on people's wallets.

But annual inflation is declining, from 9.1 percent in June 2022, its highest level in four decades, to 2.9 percent in July this year.

But that just means that prices aren't rising as much anymore. It doesn't mean that prices are falling, which would be deflation. And as I said, that's usually not good for the economy.

Is a recession the only solution to inflation?

Fortunately not, but a recession may occur.

The difficulty with monetary policy is that interest rate changes do not have an immediate effect. They usually have a delayed impact on the economy.

This makes deciding how much to raise interest rates – and how long to keep them high – a difficult matter.

Economists feared last year that the economy was heading for a recession. Instead, it recorded strong growth.

But recent weaker-than-expected employment data raises concerns that the Fed has set interest rates too high and that a sharp economic downturn could occur.

There is no guarantee that a recession is imminent. Most economists still do not believe it.

And although the Fed has kept interest rates stable since July 2023, many expect it to cut the benchmark rate by a quarter of a percentage point or even more next month.

Copyright: NPR 2024