What is Causing Inflation in 2022? 3 Factors Impacting Inflation

The past two years have been hard. Collectively we have dealt with a global pandemic, various shortages and political division. If that wasn’t enough to create collective fatigue, this past year hit us all over the head with record inflation. Inflation rose 8.6% in May 2022, the fastest rate since 1981. That rate represented inflation as a whole, but fuel increased 16.9% monthly and had a gain of 106.7% for the year!

So, what is inflation and why is it increasing so much now? Inflation is the rise of prices for goods and services in an economy. This means that when we go to the grocery store, we will pay more for our groceries. We will also pay more for gas, housing, dining out and more. In short, your money doesn’t go as far as it once did. If you did not get a raise to match inflation, then you are earning less as well. No one likes paying more without earning more.

How did we get here?

There is no simple answer as to why inflation increased at the rate that it did. Instead, there are a number of factors that led us here. Inflation is a global issue. The United States is not the only place experiencing record high prices. A few reasons for inflation include supply chain issues, strong demand and record low interest rates.

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Supply chain issues

The pandemic created many challenges and supply chain issues was one of them. When lockdowns were implemented, many industries were forced to shut down. This was particularly true for restaurants and hotels. Once the economy opened back up for business and people were ready to start spending again- these industries found it hard to find workers and supplies. If you have been out to eat lately, you may have noticed signs indicating that many places have been “short staffed” or out of certain items.

In addition to staff related shortages, businesses have a had a harder time getting the inventory that they need. When there are less workers, items take longer to produce and transport. For example, much of the increase in the cost of chicken came from shifting demand associated with the pandemic. Poultry companies struggled to find profits as closures impacted restaurants, which was a major purchaser of chicken. Many workers in the poultry industry became sick which impacted production as well. One challenge of the supply chain is that when one industry is disrupted, others will be too. For example, rising prices of chicken impacts the cost that restaurants must pay as well. That disrupts pricing for eating out.

Recent lockdowns in China have also contributed to supply chain issues since these lockdowns can cause production to slow. The war in Ukraine has also impacted the supply of both food and gas on a global scale as well.

Strong demand

The pandemic forced many people to stay inside and avoid travel and dining out. During that time, households amassed savings since they were stuck at home. Once the economy reopened, it was a perfect storm for inflation. People had more money to spend, but there was less supplies available. This gave retailers an opportunity to increase prices. Gas prices were low in 2020 because many people were working from home and travel was restricted. This meant less demand. Once those restrictions were lifted, the demand heavily increased and prices did as well. Gas prices are impacted by both strong demand and supply chain issues.

During the 2008/2009 recession, many builders stopped building homes due to the housing market crash. Many workers who previously worked building homes were forced to seek out other industries. For that reason, the United States has under built homes and is short by 3 million homes by one estimate. On top of a housing shortage, Millennials are reaching their peak first time home buying age and that has increased the demand for single family homes. A study from Freddie Mac indicates that the share of entry level homes in overall construction declined from 40% in the early 1980s to around 7% in 2019. This has impacted the housing shortage and increase in housing prices.

Interest rates

The increase in the cost of housing is not only due to shortages, but also interest rates. The Fed has provided record low interest rates which made the cost of buying a home less expensive. When home buyers can borrow money at low rates, they can typically afford to take on more debt. This encourages people to pay more for homes.

Low interest rates also impact the economy because it encourages people to borrow money. When people can borrow at such low rates, they tend to spend more. As mentioned above, this creates a strong demand and increases the prices of goods and services.

What to do?

There isn’t much the average person can do about supply chain issues, increasing demand or interest rates. Corporations play a role in this since they have been making record profits and not lowering their prices. However, waiting for corporations to become charitable isn’t a winning strategy. Instead, you should focus on what you can control. When you are buying groceries, consider cuts of meat and foods that aren’t as popular. For example, chicken wings have been high, but you may be able to find chicken legs at a lower cost.

If you are in the market for a new home or car, think long term about what you need and how much you can afford. Planning is very important right now since there isn’t really a clear path to prices going down. Typically, a drop in prices is accompanied by a recession and recessions come with a host of other issues.

Most people should be ensuring that they have a 3-to-6-month emergency fund set up to cover them in the event of a job loss or other emergency. Additional funds can be used to continue investing, put money into I-bonds and other goals. The main objective is not to panic or become despondent. Focus on the factors that you can control.

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