There’s no escaping the ravages of inflation. Far from “peaking” as some hoped, the consumer price index accelerated in May, rising at a 12.3% annual rate, the government reported Friday. Not only are the costs of necessities becoming more unaffordable, so are the costs of escaping by taking a vacation or by curling up on the couch with a video.
Inflation has become embedded in the economy and it’s affecting more of the goods and services, especially the items that we can’t do without: Shelter, food, clothing, transportation, and health care.
Sticky prices — those that change infrequently — have increased sharply in recent months.
As I wrote last month, the rising cost of renting or owning a primary residence is particularly worrisome. It’s the biggest item in the consumer-price index’s market basket. What’s more, the price of shelter is “sticky’—meaning once it goes up, it stays up.
It’s persistent, which is the opposite of “transitory.” That’s a big problem for American consumers, not to mention the headaches it creates for policy makers at the Federal Reserve who are assigned the job of bringing down inflation to tolerable levels.
The Fed would like inflation to average around 2% per year, but that’s impossible when the cost of just one item—shelter—is pushing the CPI up 2.4% per year.
Flexible prices (items that change prices frequently, such as gas and food) have long been driving inflation, but sticky prices (infrequent changes in prices) have become a real contributor in recent months. The sticky prices CPI, produced by the Atlanta Fed based on data from today’s CPI report, rose at an annual rate of 7.5% in May and is up at a 6.8% annual rate over the past three months, a 40-year high.
The CPI is “weighted” so that the things consumers spend more money on have a bigger influence on the CPI. I dove deep into the May CPI release, analyzing the table that shows which prices contributed the most to the 1% monthly rise in overall inflation. The contributions of all items adds up to 1.0, (the percentage increase in May).
Here are the top 10 contributors to May’s 1% increase.
Percentage contribution to CPI
Food & beverages
Cars & trucks
Medical care services
Video & audio services
Cable & satellite TV
The first five items are necessities. They account for about 64% of the CPI’s market basket and accounted for 77% of the increase in May.
People need to eat
The Fed is trying to reduce demand for these items by raising interest rates, but it’s hard to see how that will work. On the margin, people can cut back. They can buy cheaper items at the grocery store, or squeeze another year’s life out of the old truck, or move in with a friend, but they’ll still need to eat and have a roof over their heads and heat the house and get to work. These are necessities, not luxuries.
Prices are rising for these items not because demand for them has suddenly surged, but because the supply has been constrained, frequently by global forces, including the COVID pandemic, the war in Ukraine, and other factors, including droughts and heat waves.
Raising interest rates
won’t increase the supply of any of these necessities. In fact, raising interest rates reduces the supply of houses and other produced goods and services. The price of shelter is now the largest single contributor to inflation, but the Fed’s solution is to shut down construction of new dwellings.
Similarly, the supply of new trucks and cars will be reduced by higher costs of capital to buy and replace equipment.
If today’s inflation weren’t a global problem, such an approach might work. Foreign suppliers unaffected by interest rates in the United States might be able to increase their production to satisfy U.S. demand.
For the most part, inflation is being caused by shortages of supply, not excesses of demand. But the only way the central banks can bring supply and demand back into balance is to destroy demand by any means necessary.
In practice, that means millions of people around the world will be required to lose their jobs. But I thought the problem was a shortage of workers…
What does this mean for you and me and the millions starving in Africa? A lower standard of living.
Rex Nutting is a columnist who has written about the economy for MarketWatch for more than 25 years.