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Inflation has been sticky and stubborn, and there are no signs it's going away anytime soon. Has inflation become the new normal in America?
Expensive Inflation
Everything is more expensive than it was five years ago. Big Macs, computers, and steaks. You name it.
The Federal Reserve has missed its 2% inflation target for almost 70 consecutive months. Supply chains, oil price shocks, and tariffs have been cited as the main reasons the institution has been unable to contain inflation.
Like other major central banks, the Fed has maintained this target for decades. Economists say it is the sweet spot – or the Goldilocks zone – that balances economic growth, price stability, and policy flexibility.
Still, America’s annual inflation rate has been above this level since March 2021.
Some say that structural inflation is tamer and more stable. But the 12-month core inflation, which strips out energy and food prices because of their volatility, has also been above the 2% target for several years.
Why This Is a Problem
Market watchers have long noted that consumers have kept shrugging off risks since the pandemic, from high inflation to elevated interest rates.
Despite wages falling behind the cost of living in recent years, shoppers keep opening their wallets. Some say it is the wealth effect, meaning gains from the stock market or home prices. Others argue that consumers have depended too much on credit card debt.
Either way, households have found ways to visit shopping malls, log in to their Amazon accounts, and head to their favorite restaurants. Can this last forever?
Economic theory suggests that when inflation becomes accepted, consumers will spend now to avoid paying higher prices tomorrow. Interestingly, the University of Michigan’s recent Consumer Sentiment Index found the same, lifting the one-year inflation outlook to 4.7%.
When inflation becomes a fact of life and part of the system, business and consumer behavior changes, leading to certain economic outcomes:
· Wage-Price Spiral: Workers expect inflation above 2% and demand higher wages. Businesses give higher paychecks and pass costs on to consumers. But the cycle repeats as workers demand higher pay and firms make customers bear the brunt.
· Value Wiped Away: The value of savings, pensions, or even working-class wages fades away over time due to inflation.
· Speculation: The public, trying to preserve their money, pursues risky assets (commodities, housing, and stocks).
· Induce a Recession: The Federal Reserve must raise interest rates and print less money to induce a recession, effectively breaking inflation.
What’s Wrong With Deflation?
If persistent inflation is bad, is deflation the answer?
The conventional thinking is that an economy should not have deflation, meaning low prices. The idea is that if prices keep falling, consumers will keep delaying their purchases.
In US history, some of the most prosperous times happened during deflationary periods. The Gilded Age (1870s to 1890s), often labeled the Great Deflation, led to a historical economic boom, with consumer and producer prices falling by an average of 2% per year.
Economic historian Lew Rockwell wrote in a 2003 piece for the Mises Institute:
"Ask yourself whether during economic downturns, you want your money to grow or shrink in value? If your future job security is in doubt, do you want to pay more or less for goods? If your savings are meager, do you want them to have more or less purchasing power in the future?"
Also, will consumers really postpone buying a cup of coffee, a new pair of pants, or vitamins because prices might drop by 25 cents in six months?
Price Stability
Under Chairman Kevin Warsh, the Federal Reserve has vowed to deliver on price stability – one side of the central bank’s dual mandate – and restore 2% inflation. Judging by the Fed’s recent actions, it plans to achieve this by raising interest rates.
But can the Fed bring inflation back to 2% when tariffs, a war-driven oil price shock, and disrupted supply chains are still rippling through the global economy? By raising rates, policymakers believe they can keep higher energy costs from bleeding into the broader economy.
4 Questions
The story, in brief
Why has US inflation stayed above the Federal Reserve's 2% target?
The Federal Reserve has missed its 2% inflation target for almost 70 consecutive months. Supply chains, oil price shocks, and tariffs are cited as the main reasons inflation has been hard to contain. Core inflation, which excludes food and energy, has also stayed above 2% for several years.
Why do economists worry that inflation could become normal in America?
Economic theory suggests that once inflation is accepted, consumers spend now to avoid paying higher prices later. The University of Michigan’s recent Consumer Sentiment Index also lifted the one-year inflation outlook to 4.7%. When inflation becomes part of the system, it can change behavior in ways that reinforce more inflation.
How can persistent inflation hurt workers, savers, and the wider economy?
The text says persistent inflation can trigger a wage-price spiral, as workers demand higher pay and businesses pass those costs to consumers. It can also erode the value of savings, pensions, and wages over time. People may chase riskier assets, and the Federal Reserve may need to induce a recession to break inflation.
What is the Federal Reserve doing now to restore 2% inflation?
Under Chairman Kevin Warsh, the Federal Reserve says it will restore price stability and bring inflation back to 2%. Based on its recent actions, it plans to do that by raising interest rates. Policymakers believe higher rates can keep energy cost increases from spreading through the broader economy.
