Inflation

EMEL AKAN is White House economic policy reporter in Washington, D.C. Previously she worked in the financial sector as an investment banker at JPMorgan and as a consultant at PwC.

Economy

Inflation Stickier Than Anticipated

Companies raise prices in response to higher labor costs, fanning inflation further.

U.S. inflation showed some cooling off in July after posting large gains in prior months. Consumer prices rose at their slowest monthly pace since February, providing some relief to those in the “transitory” camp, who hold that this bout of inflation isn’t a long-term phenomenon.

But, inflation fears still linger. The year-on-year increase in consumer prices remained stubbornly high at 5.4 percent, the same as in June.

While it’s unclear when inflation could return to a level closer to its 2 percent long-term trend, economists are increasingly talking about a gradual slowdown in inflation in the months and quarters ahead.

In a recent note, Goldman Sachs economists state that current levels of inflation will prove transitory, although a rapidly tightening labor market poses a risk as it could “translate into more persistent inflation pressures down the road.”

A swift rebound in the economy and a tight labor supply have returned the upper hand to American workers. Employers are competing to attract qualified candidates by raising wages and offering bonuses and other perks.

Companies are passing along these higher labor costs to consumers via price increases, hence adding to the inflationary pressures. And a record level of open job positions in the country suggests that businesses may continue to raise wages to attract people, which could in turn boost consumer prices further.

Meanwhile, optimism among U.S. small businesses is dipping as labor shortage and supply chain constraints continue to cripple their business operations. The NFIB Small Business Optimism survey in July showed that a record-high 49 percent of small firms struggled to find workers to fill open positions.

The survey also found that 52 percent of small business owners raised the prices of their goods and services to mitigate higher costs.

In addition, the COVID-19 Delta variant is deepening already substantial supply chain disruptions, putting pressure on prices. For example, setbacks in the Asia-Pacific region, according to Goldman Sachs, are delaying the normalization of car prices.

The semiconductor shortage amid the pandemic continues to hammer auto production worldwide. Nissan announced on Aug. 10 that it would close its large factory in Tennessee for two weeks because of computer chip shortages. More than a dozen factories in North America and Europe have halted or reduced operations in recent weeks.

The global scarcity of chips has tightened new and used vehicle inventories and pushed up prices this year. Prices of new and used vehicles have been on the rise for months, making them a major driver of inflation.

While used car prices stabilized in July, rising only 0.2 percent over the month, they are still over 40 percent above their pre-COVID trend. And the yearly inflation for new vehicles stood at 6.4 percent in July, the largest gain in nearly four decades.

Persistent supply shortages have gone beyond the auto sector and affected prices of consumer electronics and shipping, as well.

We’re going to head into a very high rent period in the next 10 years.

Ken McElroy, CEO, MC Companies

How Sticky Is Inflation?

Inflation has turned into a major source of disagreement among economists, as they are divided over the key question of how long high inflation could stick around.

The Federal Reserve’s latest forecast shows that the inflation will be 3.4 percent this year, before settling back down to just over 2 percent in 2022 and 2023.

“The risk is that higher inflation may have a longer-than-expected ‘tail’ before normalizing, or perhaps a more enduring structural component,” Nanette Abuhoff Jacobson, global investment strategist at Hartford Funds, said in a report.

One area to watch closely, she said, is rents and shelter, the largest component in the consumer price index.

Rents dropped significantly during the pandemic across the country, but now they’re surging at a rapid pace, as more workers return to metro areas, boosting demand for rental apartments. A sustained increase in rents could lead to more persistent inflation, as price increases are hard to reverse.

“We’re going to head into a very high rent period in the next 10 years,” Ken McElroy, CEO of MC Companies, a real estate investment firm, said in an interview.

Soaring home prices are also pushing people to the rental market. If rents track home prices as in the past, then this could be “a big deal” for inflation, according to Jacobson.