Inflation Spotting: What’s Causing Inflation in 2021
Exploring the stories attached to the front runners in the CPI.
Federal Reserve Chair Jerome Powell said something curious about inflation at the last FOMC meeting. Powell first noted that many of the big changes in the consumer price index (CPI) were “tied to a handful of categories” (See my last post on the topic here). But then he went on to say, “And each of those has a story attached to it.” What did he mean by that? Let’s walk through the stories behind the prices and break down what’s causing them each to change.
The Story Behind a Price Change
My last post on inflation already explained that the United States appears to be experiencing increases in relative prices, not an increase in the general level of prices (i.e., inflation). But with that said, what is causing these price changes in the first place?
On one side, prices can change because of factors that affect the supply of goods and services. If there is a change in the cost of production, it’s possible that said cost will get passed on to consumers. This often comes up in debates about raising the minimum wage. Proponents argue workers deserve a living wage and opponents counter that a higher wage will lead to more expensive products.
On the other side, prices can change because of factors that affect the demand for goods and services. If there is a sudden surge in demand, prices may increase. In times of crisis (i.e., think about gas prices after a hurricane), the practice of raising prices in response to unusually high demand is often referred to as “price gouging.” But it’s not always so dramatic. An easy example to think of is collectibles. As some item becomes more popular, demand increases, and there is upward pressure on the price.
So with that understanding in hand, let’s explore the stories behind each of June CPI’s front runners.
Table 1. Big Changes in the CPI
Car and Truck Rental: +87.7%
Car and truck rental prices have skyrocketed in the last 12 months. However, that timeline should already be a hint about what’s gone awry. Last year, the rental car industry was struggling to survive amidst the lockdown. Despite being one of the largest companies in the industry, Hertz had filed for bankruptcy in May 2020. And they were not alone: many companies liquidated their fleets to get by.
Fast forward to June 2021 and America is on the move again. Yet while Americans can book a trip with a click, it’s not so easy for rental companies to replenish their fleets. And this clash between demand and supply is important because rental companies often use dynamic pricing. In short, “dynamic pricing” means that companies change their prices on the spot. That is why the same car, with the same company, can be two drastically different prices if you book it during a holiday versus the off-season. And that is why prices have been particularly responsive (at nearly double the percent change of used car prices!) in response to the current clash between supply and demand.
Used Cars and Trucks: +45.2%
But if renting cars and trucks is tough, buying used isn’t much better. Most people have likely heard of the ongoing semiconductor chip shortage. However, what those semiconductors are and what they are used for is probably lesser-known. For our purposes, all that matters is that the average vehicle contains around 1,000 semiconductors and electric vehicles often have triple that. Thus, without the available parts on hand, new car and truck production has been largely shut down.
But this section is about used cars and trucks, not new ones. Right? Well, without new cars to satisfy demand, many people have been buying used or holding on to what they have. The latter option may appear to be a good thing for the shortage. However, trade-ins are one of the main sources of used cars for the market. And worse yet, the other main source of inventory for the used market is rental companies (i.e., the companies that sold off all their inventory and are now racing to replenish their fleets). So once again, a clash between supply and demand is turning the market upside down.
Gasoline: +45.1%
With all this talk about cars and trucks, it’s only natural to turn to the price of gasoline. There are two pieces of this puzzle to address: what happened last year and what’s happening now.
Last year, gas prices had fallen 23.4% relative to the year prior. Between the lockdown, fears over the virus, and the still long wait for a vaccine, people were not driving as much. So, prices fell. It may not explain the full story, but it is worth stressing that over half of the 45.1% increase in gas prices over the last 12 months were gas prices returning to normal.
Now, the other half of the story is slightly more complicated. The Organization of Petroleum Exporting Countries (OPEC) is largely in control of how much oil reaches the market. Yet it wasn’t until mid-July that they were able to agree to increase oil production as the world reopened. Because of this delay, it will likely be some time before said increase has any impact on the market. Therefore, as Americans continue to drive more and more, they will be bidding over the same limited supply.
Laundry Equipment: +29.4%
Ok, full disclosure: the price increase for laundry equipment has me stumped. In April, Procter & Gamble (the maker of Tide detergent) announced that it would be increasing prices across products due to the high costs of shipping and raw materials. Yet, this doesn’t quite explain why laundry equipment is amidst the front runners and other products are not. At best, I can see the coin shortage and concerns about going out influencing a rush of demand towards doing laundry at home. But that still feels like a bit of a stretch.
If you have any thoughts or insights, comment below! I’d love to hear what you think is going on here.
Airline Fares: +24.6%
Luckily, we do get to end on a high note.1 The increase in airline fares has been a long time coming. Although the entire planet suffered in the wake of COVID-19, the airline industry was dominating headlines last year. Airlines went from record profits to near collapse in the course of six months. For example, Delta Airlines lost $400 million a day in May 2020. So, the airlines started slashing schedules, dropping airports, selling assets, and furloughing workers.
There’s only one problem: rebuilding an empire can take a lot longer than it takes to destroy it. Much of the world has reopened and people are traveling. However, airlines are having a difficult time re-hiring pilots, flight attendants, and crews. And frankly, it would probably be wise of them to be cautious in their own reopening considering the pandemic is still ongoing.
Thus, here we are again at the crossroads of supply and demand. There’s a country full of people itching to get out of the house, yet there just aren’t enough seats on the limited planes available.
The Missing Chapter: Money Printers and Wallet Burners
Now that the stories behind the price changes are clearer (well, except for what’s happening to laundry equipment), it’s time to address the one story that’s missing: excess money. To get a rise in the general level of prices, the Federal Reserve need only flood the market with more money than people want to hold. With extra money burning holes in their wallets, people will demand more of everything. Thus, prices, in general, will rise.
The past year has certainly been a busy one for the “Fed’s money printer.” However, there is a critical difference between “money” and “excess money.” As it stands, it seems like the stimulus checks were mostly sterilized by the income that was lost due to the lockdown. In other words, a lot of money was injected into the system, but it looks like it might just come out in the wash.
Wednesday’s CPI release, and the next few that follow, will be critical for figuring out what the future will look like. However, at the moment, it looks like the price increases in the U.S. economy are mostly a result of the market still trying to shake off COVID-19.
Apologies. I couldn’t resist.