Three Years that Changed the World
Peter Bernstein, Chief Economist, firstname.lastname@example.org, 312-431-1540 x1515
The period before early 2000 may go down in popular history as “The Lull Before the Covid Storm.” During a lengthy and largely smooth recovery from the Great Recession, the U.S. Consumer Price Index (CPI) struggled to rise above 2% per year. Inflation was not an important economic concern for the U.S. or the world during the 2010s.
Covid-19 struck with a fury in the United States in March 2020, and between governmental lock-down mandates and people deciding on their own to stay home to avoid exposure, the U.S. economy went into a free-fall. GDP contracted at an annualized rate of 32% in the second quarter of 2020, the largest quarterly decline in U.S. history. Prices fell in the early months of the pandemic, sparking some concerns that a Depression-like deflationary spiral could hit the economy. The Federal Reserve responded with expanded lending, but had little leeway to reduce interest rates, which had remained historically low since the Great Recession. In the spring of 2020, Congress appropriated funds through the Coronavirus Aid, Relief, and Economic Security (CARES) Act and other supplemental legislation, which sent a series of stimulus checks to most Americans and provided expanded benefits to the millions of unemployed workers. In March of 2021, an additional $1.5 trillion were appropriated through the American Rescue Plan Act. These checks were a lifeline to the economy and society.
Demand Recovers but Supply Cannot
As the economy recovered, consumer spending – bolstered by government stimulus and a quick, but partial rebound in employment – rose sharply and shifted away from services to goods. But manufacturers struggled to find workers, and continued shutdowns around the world left many companies without critical components. Decades of just-in-time inventory policies had left companies with little slack resulting in long delays and rising prices. A chip shortage reduced the supply of new vehicles which caused their prices to rise which in turn led to rising demand and soaring prices for used cars. Food prices rose, even before Russia’s invasion of Ukraine. Meat packing houses became Covid-19 incubators and greatly reduced operation. More recently, a bird flu outbreak in the fall of 2022 caused farmers to kill millions of chickens causing egg prices to hit record highs.
Consumer prices started rising in the second half of 2020 but for the year inflation remained below 2%. Starting in 2021, however, price increases began to accelerate. In the second quarter of 2021, inflation reached an annualized rate of 5.4%; in the third quarter the annualized inflation rate was 9.5%. Inflation continued into 2022, with the annualized inflation rate reaching 11% in the first half of the year, the highest inflation rate in over 40 years. Though a result of multiple factors, it was a case of too much demand and too little supply, a recipe for higher inflation.
Source: Bureau of Labor Statistics
And Then Came War
Much of the increase in prices in 2022 was a result of Russia’s invasion of Ukraine in late February. Both Russia and Ukraine have been major world exporters of food grains and the war drastically curtailed grain exports from the region. And Russia is a major oil and gas producer. Regardless of Western efforts to sanction oil and gas purchases from Russia, the sheer uncertainty caused by the war sent gasoline prices in the U.S. to above $5/gallon – more than double their price from just one year earlier.
The Fed Acts
Soon after Russia’s invasion, the Federal Reserve started an aggressive series of interest rate hikes, taking the fed funds rate from near zero to near 4.5% by the end of 2022. These rate increases appear to have slowed the economy and reduced inflation which hit its year-over-year peak of 9.1% in June. Nevertheless, prices rose 6.4% in 2022, on top of the 7.1% increase in 2021.
In short, the past three years brought a changed inflationary landscape. But not all prices increased at the same rate and differences across major categories provide insight into how the pandemic, and other events, impacted the economy. With the release of the December 2022 CPI data, RCF has calculated price changes over the past three years (from December 2019) compared to price increases for the three years from 2016 to 2019.
Comparison of inflation before and after the pandemic
Sources: Bureau of Labor Statistics and RCF Calculations
From 2016 to 2019, the CPI increased a total of 6%, in line with the Fed’s goal of 2% annual inflation. From 2019 to 2022, CPI rose 15%, an annual average of 5%, with 3-year inflation 9% higher than before the pandemic. Core prices have increased 13% over the past three years, 7% more than the 6% increase from 2016 to 2019. The producer price index showed an even greater inflation disparity – prices were up 18% over the last 3 years compared with a 7% total increase from 2016 to 2019.
Interestingly, while inflation has at times substantially reduced workers’ real income, that hasn’t been the case when looking at the entire period from 2019 to 2022. Hourly earnings of private sector workers rose 16% (1% more than inflation) while earnings of non-supervisory workers rose 18%. But for both types of workers, real wages rose less from 2019 – 2022 than they did from 2016 – 2019.
Looking at the individual components of the CPI provides some key insights:
* Food at home prices rose 24% over the past three years, much more than the 2% total price increase from 2016 to 2019. The War in Ukraine is a big factor here.
* Labor shortages hit restaurants, which along with increased commodity prices, caused the price of food away from home to increase 19%, 11% more than the increase from 2016 to 2019.
* Vehicle price inflation was nearly zero from 2016 to 2019 but prices shot up due to pandemic-induced supply chain problems, chip shortages, and other factors. Over the 3 years, new vehicle prices have risen 21% and prices for used vehicles are up a startling 38%!
* More evidence of the supply chain problem is found in the prices of household furnishings. They rose 18% over the past three years compared to only a 2% rise from 2016 to 2019.
* Motor fuel price inflation was not that much higher in our three-year comparisons. From 2019 to 2022, motor fuel prices increased 25%, but they were up 17% from 2016 to 2019 indicating that there are some longer-term factors driving the price increase.
* Perhaps surprisingly, rents (up 14% since 2019) have increased a bit less than prices in general. The 14% increase is also not much more than the 11% increase from 2016 to 2019, which was far more than the increase in the overall price level during that period.
* Of our 18 components, only medical care saw lower inflation over the past three years than from 2016 to 2019. And only three components (apparel, public transportation, education and communication) had annual average price increases at or below the Federal Reserve’s 2% target.
For most of the last three years, inflation has been well above the 2% annual average that the U.S. economy had experienced for more than a decade. Recent data show inflation declining and perhaps this period of high inflation will be just a brief interruption in our low-inflation history. But with the war in Ukraine still raging, Covid-19 still infecting thousands, and labor market and supply chain issues not yet fully resolved, the inflation outlook remains uncertain. RCF will continue to monitor monthly changes in prices and provide regular analysis of inflation trends.