Inflation and the Battle to Tame It Will Persist

Higher costs for goods and services permeated the economy in recent months, but will inflation persist or return to the 1% to 2% range that we have enjoyed in recent decades? By July, the consumer price index for urban consumers (CPI-U) increased by 8.5% from the previous year. Inflation reached a 40-year peak in June, spurred by a perfect storm of labor shortages, supply chain issues, geopolitical issues, a war in Europe and high energy costs. The tight labor market led to higher wages for workers and higher prices for consumers while de-globalization and supply chain disruptions left store shelves bare of some items. Easy monetary policy and market intervention by central banks around the world has led to an influx of capital for all types of investment, contributing to inflation. 

Stronger than expected demand combined with supply disruptions and the war in Ukraine drove energy costs higher. Building upon the lackluster demand in 2021, energy prices were nearly 33% higher than last year in July. Though gas prices, the primary factor in CPI-U growth pulling back from more than 9% in June, have moderated in the month of July, the outlook for utility prices is a movement higher, particularly as winter approaches. 

The price of food rose in July, increasing by 10.9% compared with last year. Another confluence of events, labor shortages and higher wages for farm workers and plant employees combined with higher transportation costs increased prices for consumers. In addition, bad weather and water restrictions reduced some crop harvests while poultry producers were hit by avian flu.  

Long a source of disinflation, goods prices accelerated sharply in early 2022 before moderating slightly in recent months. The price of goods, less food and energy, were up by 7.0% in July compared with one year ago. With little end in sight for supply chain issues and increased labor input costs, the higher pricing for goods will likely persist. As the category accounts for roughly 20% of the CPI-U, the rising prices for goods should lead to elevated inflation through the near term. 

The rise in prices for some goods and services may prove to be temporary, yet others are driven by structural shifts that will add to inflationary pressures for some time. Energy costs tend to be volatile, and while high gas prices are a burden to consumers, producers typically increase output to meet demand.

Other price increases may be more long-lasting. The weakening of globalization, including trade sanctions and protectionist trade policies, reduced flow of goods across borders and the rise of onshoring production, will lead to higher prices of many goods. Globalization, particularly utilizing low-cost manufacturing abroad, drove disinflation for two decades and the reversal will keep inflation higher for a longer period. However, the on-shoring and near-shoring of production, as well as developing greater supply chain resiliency, will fuel space demand in the industrial real estate sector. Of course, making the supply chain more resilient will add costs, much of which may be borne by consumers. 

Demographic shifts already underway may also maintain higher inflation. The aging workforce is leading to a growing number of retirees, one of the reasons for the current labor shortage. As the number of consumers rises faster than the number of producers, or workers, wages may rise further. Thus far, higher inflation has not impacted demand for housing, particularly in the apartment and single-family home rental segments with strong absorption and rent gains. With occupancy near historic highs and a shortfall of housing development for decades, market rents may continue to outpace inflation.

The Federal Reserve played a role in the surge in inflation. The zero-rate policy, which ended in March, was in place for much too long. Purchases of federal government debt also continued, helping the Federal Reserve balance sheet approach $9 trillion. The central bank’s support of the housing market through agency bond purchases helped spur the elevated house price gains during the last two years. 

Following three rate hikes of 75 basis points each and a strongly worded message during the recent Jackson Hole Economic Symposium, the Federal Reserve’s resolve to tame inflation should no longer be second guessed. The Federal Reserve is likely to continue to raise short-term rates as well as reduce its balance sheet. It would seem that the price control portion of the dual mandate will be the primary focus versus full employment in the near term. Perhaps the Federal Reserve is acknowledging that it fell behind the curve in the fight against inflation in the early part of the year. In any event, Federal Reserve Chairman Jerome Powell noted that “Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy.” He went on to further state that “Central banks can and should take responsibility for delivering low and stable inflation.” Chairman Powell closed his speech by saying, “We will keep at it until we are confident the job is done.” 

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