Acknowledging its initial mistake, the Fed and the government are now taking the necessary steps to curb inflation. And the situation is getting trickier for the government as the country’s mid-term election inches closer. Some economies are using different approaches to tackle inflation.
IN the middle of last year, the US Federal Reserve (Fed) thought the inflation situation would be transitory, expecting it to peak for a few months, then receding close to its 2% target.
One of the arguments was that pent-up demand, which was induced by the multiple months of lockdowns, and supply chain disruptions where global trades were halted, would normalise over the short-term.
This was when inflation was averaging at 5.4% between June 2021 and September 2021.
However, until the end of the year, inflation did not recede due to persistent imbalances in supply and demand. And as the US economy reopened and more people returned to the labour market, the economy recovered, and demand increased. But supply was not able keep up with demand as some parts of the economy were not fully operational.
Some of major trading partners were still having problems with the spread of Covid-19 and access to vaccines, and this had created problems for the United States, since it imports most of its goods and services.
In fairness, the high inflation situation is a global phenomenon.
Inflation rates have doubled in 37 out of the 44 advanced economies over the past two years, according to a Pew Research Centre analysis.
Acknowledging its initial mistake, the Fed and the government are now taking the necessary steps to curb inflation. And the situation is getting trickier for the government as the country’s mid-term election inches closer.
Some economies are using different approaches to tackle inflation.
Most of the developing economies such as Indonesia, Malaysia and South Korea preferred to target prices directly via price controls and subsidies.
Advanced economies such as the United States, the United Kingdom and Australia used their monetary policy to keep inflation in check.
Overall, high inflation in the United States is caused by both supply and demand factors.
Apart from the imbalances in the economy, the Russia-Ukraine war has been the other contributing factor since March.
Global commodity prices jumped with Brent rising 15.5%, peaking above US$125 (RM553) per barrel – the highest price since the global financial crisis.
This caused energy prices in the United Sattes to spike.
Specifically, energy prices surged by 29.9%, which bumped up transportation-related cost much by 21.4% while housing utilities increased by 15.7%.
It is worse for most Americans who need to drive to work. Petrol prices skyrocketed by 58.5% to US$4.77 (RM21) per gallon (3.8 litres) as of the first week of this month.
Higher petrol price
The higher petrol price has ripple effects on everyday goods, especially food due to logistics reasons.
Food prices such as flour, meat, fish, fruits and vegetables went up drastically by 8.6% on average this year.
The labour market in the United States is already improving remarkably.
The unemployment rate declined to 3.6% in May – the lowest level since the pandemic started.
Sectors that were severely affected by Covid-19 such as the services industry, are also improving and have almost rebounded to pre-pandemic levels.
Overall wages are also recovering as well, rising by 5%.
This pointed to a tight labour market, which means price pressure will stay elevated from the demand side.
Despite the improvement in the labour market, high inflation is taking a toll on salaries.
Surging petrol prices forced Americans to hold back their travel expenses, especially during the summer, and the higher food prices are stopping people from dining out.
The whole situation resonated with what the Fed experienced in the 70s and 80s, when the central bank tightened money flow into the economy as a result of higher commodity prices.
So far, the Fed has responded by increasing the interest rates by 150 basis points.
In the meantime, global commodity prices have fallen, suggesting the action by the Fed and other central banks is slowing down demand.
The latest inflation expectation has also flattened for the past three months, but not receding as yet.
Long-term interest rates, including mortgage rates, have also gone up due to the Fed’s quantitative tightening.
For instance, the 30-year average mortgage rate increased to 5.3% as of this month from 3% early this year. The increasing mortgage rates forced borrowers to pay more on interest during high inflation, worsening the cost-of-living situation.
Indicators such as retail petrol price and tight labour market are suggesting that inflation may not have reached its peak.
Therefore, we might be seeing higher inflation.
Energy price uptrend
As winter approaches, energy consumption should be higher, and this could keep energy prices elevated until the end of the year.
Based on the Federal Open Market Committee’s (FOMC) expectations, inflation will cool to 5.2% this year, 2.7% in 2023 and 2.3% in 2024, which is closer to the Fed’s 2% target.
The Fed is committed to keeping inflation low. Price stability matters for every central bank, including the Fed, since it will lead to stable growth.
More FOMC members have pointed out that inflation was the main priority, and they would not mind pushing the interest rates higher and faster, at the expense of slowing down the economy.
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