By Aniket Mittal
Overview:
In the last few years, you may have seen rent skyrocket, prices for gas soar, and the stock market plummet. You may have blamed inflation and the current economy on COVID-19. Although the pandemic is one factor, the true source of this inflation goes beyond that. As a result, it’s important to understand how the economy is currently fluctuating and make financial choices accordingly. This article is an extension of Part 1 and attempts to explain the reasoning for the inflation mentioned in Part 1.
First, what is inflation?
In simple terms, inflation is the general increase in prices of goods and services in an economy. During high inflation, the relative salaries of the majority of the population remain the same but as the prices of goods increase, the relative purchasing power of currency decreases. Additionally, often, the government is forced to print more currency, usually to pay back debt, depreciating the value of the currency. It’s important to understand how inflation works in order to maintain a strong financial position despite a waning economy.
In order to measure inflation, various metrics are used. For example, Consumer Price Index for All Urban Consumers (CPI-U) is one of the most popular indicators, often used for more consumer products such as apparel, automobiles and other products. Another indicator, the Personal Consumption Expenditures (PCE) index is used by the Federal Reserve and is similar to the CPI-U to measure the changes in goods and services.
Supply-Chain Shortages / The Pandemic:
One reason for the 2022 inflation is indeed the pandemic and a strained supply chain.
Historically, a lack of sufficient U.S. supply and domestic manufacturing has pushed us to rely on foreign manufacturing. Much of our goods and services come from other countries such as China, India and Japan. However, although, during pre-pandemic, favorable balance between supply and demand was sustained, during the pandemic, demand skyrocketed with the need of masks, ventilators and other equipment. To make matters worse, unemployment increased as businesses could no longer stay open and isolation was enforced. These delays along with further shortages of semiconductors delayed production and distribution, leading to the massive supply-chain shortages apparent today.
Thus, although some claim that an easy way to boost the economy is to increase demand, this is simply not the case. Although, during past recessions, we may have been able to create demand by investing in the economy, the current inflation is driven by different factors and can only be aided by helping this supply chain shortage.
The War in Ukraine:
Another crucial factor to the rising inflation was the oil market and the war in Ukraine. As a result of Russia’s invasion into Ukraine, many countries including the United States have placed sanctions on Russian oil. As a result, the prices of gas skyrocketed increasing the inflation as well as furthered the supply chain shortages mentioned above. Oil directly contributes to the rising costs of goods and services because oil and gas is required for nearly every single step in the production process. Transportation, manufacturing, heating and other processes are solely reliant on oil so any increase in the prices in oil directly contributes to inflation. Additionally, fluctuations in oil demand led to volatility in the oil marketing, only contributing to a waning economy.
As a result, a crucial component of reducing inflation in the United States is to decrease oil dependency or to look for other sources of oil. In fact, the recent Inflation Reduction Act, new alternatives towards oil and fossil fuel usage such as fuel-cell and renewable technologies are supported in order to reduce oil dependence and reduce carbon emissions.
Labor Market:
One other factor was the waning labor market. As a result of the pandemic and rising inflation, many workers were laid off. This is because many services were abandoned such as airplanes, restaurants and transportation. As a result, there is a tight labor market post-pandemic where employers are encouraged to increase wages to entice workers. Higher wages means higher costs of goods and services leading to the inflations that you see today.
As a result, supporting a strong labor force is crucial towards reviving the economy. In fact, such efforts are being carried out as the recent Infrastructure Bill attempted to revive both the current manufacturing industry as well as bolster the labor market.
Is Recession Likely?
Although many economists have conflicting opinions towards the likelihood of a recession, CNBC reports that recession is likely to occur in 2022 and 2023 as a result of five months of zero economic growth. Thus as a result, it’s important to be cognizant of the current economic situation so that you can take steps towards protecting financial stability, bolstering the economy, and making smarter financial decisions. Part 3 of this article hopes to explain what steps you can take to improve your financial situation during the current economic crisis.