Inflation has many consequences, including higher prices, increasing interest rates, and plummeting stock prices. This means that economies still recovering from the recession suffer from stalled growth and even the fears of another recession.
Price spikes in sectors like airfares, hotels, and vehicles in 2021 drove an increase in inflation. The average inflation at 2.8% in August 2021 for categories with smaller inflation like food, housing services, and energy was much higher than 1.7% in February of 2020.
The Fed’s targeted inflation is 2%, but core inflation in the U.S. is higher at these levels. According to some, the core personal consumption expenditures (PCE) inflation will likely be between 2.2% and 3.2% because of the continuing increases in housing and vehicle prices.
Expected Effects of Higher Inflation
Trillions have already been pumped into the economy to help the unemployed, families, and businesses struggling with the effects of the pandemic. That is a lot of extra money flowing in the economy at a time with the lowest interest rates ever. This is pushing stock prices to record highs. Additionally, the flow of money creates a surge in consumer spending, increasing the demand for goods and raising prices.
Therefore, the disruptions in supply chains, a very loose monetary policy, higher energy prices, and increased consumer demand have led to swelling inflation. It is expected that if the pandemic eases, so will these effects on the inflation rate. Still, in the meantime, the Fed is gradually tightening its monetary policy with quantitative easing to help rein it in.
Increased interest rates
If the measures currently taken by the Fed cannot harness rising inflation, one of the necessary measures to curb it is an increase in interest rates toward the middle of 2022. Increased interest rates immediately affect consumers with mortgages and other financing obligations.
Falling stock market prices
Any increases to the interest rate to curb inflation will affect the earnings of the stock market. Currently, the stock price-earnings ratios are higher than other troubled times, namely before the crash of 1929 and that of 2007-08. If several interest-rate increases are required, this will immediately cause a sharp adjustment to the stock market. Moreover, these falling stock prices will affect consumer spending because of the high number of retail investors. The possible outcome will resemble pulling a handbrake on economic recovery and the likelihood of a recession.
No Major Changes to Inflation Expected
According to a report in Market Watch, Fed Chairman Jerome Powell has said that any inflation on the back of a full recovery is expected to be minor and brief. The groundwork for a more relaxed approach, known as inflation averaging, was already laid last year. That means that if meager inflation lasts for a while, the Fed averages it with the slightly higher inflation that follows.
According to the economists interviewed for the report, one of the main worries for the Fed is the pandemic’s effects on the labor market instead of higher inflation. With 10 million people still unemployed, the pre-pandemic unemployment levels that were 3.5% are not expected to recover any time soon.
The central bank may have to increase interest rates if inflation surpasses 3% in 2022, but Powell has reassured the nation that the Fed will avoid any panic-induced moves. This is because inflation has been at its lowest and most stable over the last three decades than ever before.
In an interview with Business Insider, Treasury Secretary Janet Yellen reiterated that even though higher inflation persists amid the global energy crisis and supply shortages, it won’t spiral out of control. This is because price growth is expected to cool.
Yellen is quoted from the report: “I expect that the decade-high price growth will slow down sometime after the middle of next year.”
Final Word
Inflation is not necessarily a bad thing, but it affects some people more than others. For workers, higher inflation means they can ask for bigger salary increases to match the cost of living. It also means that borrowed money suddenly becomes cheaper, something positive for those with mortgages and loans. Pensioners and those living on a fixed income are unfortunately most affected because their purchase power decreases. On the other hand, if they have savings, the higher interest rates mean they earn more on those.
