Used cars and washing machines cost a lot more now than they did a year ago. In fact, U.S. consumer prices are up overall in the last year as the pandemic disrupted supply chains, and households flush with government stimulus payments stoked demand for goods and services as businesses reopened. Some economists think an era of faster inflation may be approaching, while others call the pace of recent price increases “transitory” and expect it to slow. Let's examine...

A transitory surge in inflation can create some headaches, but tends not to move the needle on the underlying trend in prices.

On the other hand, sustained high inflation can be bad for the economy. Wages typically do not keep pace, so people, especially those with lower incomes, struggle to make ends meet (Psst: wages have lagged inflation for four months running already). It can also distort financial and currency markets.

The pandemic has certainly been disruptive, and much can be explained by changes in people's behavior and the sudden shock to supply chains around the world.

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Some sectors have risen…

The U.S. economy has been on a roller coaster the last year, but because of government programs household budgets were largely kept whole. During the “lockdown” months, spending increased around the home on things like cars, appliances, and food. Supply chain issues (also caused by the pandemic) meant manufacturers struggled to meet that increased demand.

The result was Economics 101: Higher demand + lower supply = higher prices.

On reopening, people resumed activities like eating out and traveling that they had given up during the pandemic. That has also meant a surge in demand, and rising prices (again) in other sectors. Prices for rental cars are up a whopping 83% since the start of the pandemic. The reason: when travel stopped, rental companies sold off parts of their inventory to pay the bills. When travel picked up again this summer, they did not have enough cars to meet demand. So again, lower inventory and increased demand led to higher prices.

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Others have fallen...

A lot of Americans are still working from home as the Delta variant has kept case numbers high and pushed back plans for returning to the office. That has depressed demand for things like office attire, personal care products, and airfare.

Air travel overall remains in a precarious position. People are booking vacations, but not as much as they did before 2020. And business travel will likely continue to see low numbers until workers are back on site.

What does the Fed think?

Overall, Fed officials seem to think the inflation spike is transitory, and it will take more time to see if that is true. But they are worried and watching, though not just at the headline numbers.

Beyond price changes themselves, the Fed places greater stock on how businesses and households expect inflation to behave in the future, a concept known as inflation expectations. Expectations are thought to have a strong influence over actual spending decisions, over business pricing choices, and thus over inflation itself. The Fed is not too worried as long as expectations are settled, or “anchored” in Fed-speak. Over time, even while prices have spiked, inflation expectations have remained pretty constant, and that remains the case.

A little inflation might not be so bad

The Fed set a 2% inflation target in 2012 and since then the U.S. has been on the low side of that. Here is how the actual Personal Consumption Expenditures Price Index (another common gauge of inflation that the Fed favors over CPI) compares to that 2% target:

Overall it is a touchy moment. The Fed has had episodes where it attacked high inflation, notably in the 1970 and 1980s, at the expense of higher unemployment. It has had episodes, including the decade just concluded, of inflation that was lower than its target. But it has never had a moment when the central bank said it was going to let inflation get a bit high then edge it back down. Fed officials feel they have the tools and expertise to do this. They also have plenty of skeptics. Whether they succeed rests on all those recent price shocks - to used cars, to food, to energy, and other items - proving to be “transitory”.