Why Inflation Is Lower Than It Looks

Up, up, and away? Photo: Frederic J. Brown/AFP via Getty Images

Prices haven’t risen this fast in decades. Over the past 12 months, inflation in the U.S. rose by 5 percent, according to the Bureau of Labor Statistics, its quickest pace since August 2008. The “core” consumer price index (CPI) — which strips out volatile food and energy prices — is rising at its fastest annual rate since 1992.

Media coverage of May’s CPI report has front-loaded these facts. Conservatives and bitcoin merchants are now citing them to substantiate their prophecies of the dollar’s imminent debasement. But before you convert your bills to crypto (and/or start using them as Kleenex), you should consider three pieces of critical context:

• Today’s annual-inflation numbers use consumer prices in spring 2020 as their baseline. As you may remember, last May was a somewhat unusual time for the U.S. economy. In much of the country, Americans were quarantined in their homes. The appeal of various forms of consumption — from retail shopping to taking a vacation — was severely diminished. And the price of such goods and services was therefore exceptionally low. Between February 2020 and May 2020, airfare prices fell by 30 percent, car-rental prices by 23 percent, and hotel-room rates by 14 percent. Meanwhile, apparel was 7.9 percent cheaper in May 2020 than it had been 12 months earlier.

• The pandemic had peculiar implications for the car market. Faced with a global recession, manufacturers of semiconductors — a critical input for many new vehicles — slowed down production. Car-rental companies responded to the collapse in tourism by selling off their fleets. Now, as the economy recovers, a global shortage of semiconductors is limiting the supply of new cars — while Enterprise, Alamo, et al. are scrambling to replenish their fleets by buying up used vehicles. Together, these developments have put major price pressure on the automotive market.

• Spikes in the prices of car rentals, used cars, new vehicles, and airfare collectively account for roughly half of last month’s inflation. Used cars alone comprised about one-third of the CPI increase.

Take these facts into account and May’s inflation report looks much less concerning. Hotels, airfare, apparel, and car rentals got a lot more expensive between the early days of the plague and today. But unless we want these industries to go under, that is a good thing. Conditions in the car market are genuinely concerning. And policy-makers should explore ways they can help expedite an expansion in the supply of new vehicles. But there is little doubt that the global automotive industry is capable of resolving pandemic-induced bottlenecks — and increasing production to match demand — in the medium-term future. Capitalism has its flaws. But an inability to produce (environmentally damaging, socially ruinous) personal vehicles in high volume is not one of them.

All this said, one can’t chalk up all of last month’s inflation to the pandemic’s low baselines or temporary supply-chain disruptions. The price of “food away from home” did not fall during the pandemic’s early months. And it is now 4 percent more expensive than it was last spring. This likely reflects long overdue wage increases for fast-food workers. And since wages are sticky (meaning it’s hard to cut workers’ pay without triggering a crisis in morale), such price increases could prove durable. One could similarly attribute part of the rise in apparel prices to recent wage gains for retail workers. Thanks in part to Congress’s extension of $300-a-week unemployment benefits until September, demand for workers is currently outstripping their supply, enabling laborers to secure better terms from desperate employers.

It’s possible that COVID’s impact on global supply chains and production will prove more durable than economists anticipate and that this will render inflation less transitory than the Federal Reserve expects.

But for the moment, the bulk of inflation appears to derive from (1) imminently resolvable bottlenecks and (2) pandemic-vulnerable industries reestablishing their pre-pandemic prices. So you should wait for more data before blowing your nose with a greenback — and policy-makers should do the same before sacrificing full employment on the altar of price stability.

Why Inflation Is Lower Than It Looks