essay over inflation

What is inflation?

Inflation refers to a broad rise in the prices of goods and services across the economy over time, eroding purchasing power for both consumers and businesses. In other words, your dollar (or whatever currency you use for purchases) will not go as far today as it did yesterday. To understand the effects of inflation, take a commonly consumed item and compare its price from one period with another. For example, in 1970, the average cup of coffee cost 25 cents; by 2019, it had climbed to $1.59. So for $5, you would have been able to buy about three cups of coffee in 2019, versus 20 cups in 1970. That’s inflation, and it isn’t limited to price spikes for any single item or service; it refers to increases in prices across a sector, such as retail or automotive—and, ultimately, a country’s economy.

Get to know and directly engage with senior McKinsey experts on inflation.

Ondrej Burkacky is a senior partner in McKinsey’s Munich office, Axel Karlsson is a senior partner in the Stockholm office, Fernando Perez is a senior partner in the Miami office, Emily Reasor is a senior partner in the Denver office, and Daniel Swan is a senior partner in the Stamford office.

In a healthy economy, annual inflation is typically in the range of two percentage points, which is what economists consider a signal of pricing stability. And there can be positive effects of inflation when it’s within range: for instance, it can stimulate spending, and thus spur demand and productivity, when the economy is slowing down and needs a boost. Conversely, when inflation begins to surpass wage growth, it can be a warning sign of a struggling economy.

Inflation affects consumers most directly, but businesses can also feel the impact. Here’s a quick explanation of the differences in how inflation affects consumers and companies:

• Households, or consumers, lose purchasing power when the prices of items they buy, such as food, utilities, and gasoline, increase.
• Companies lose purchasing power, and risk seeing their margins decline , when prices increase for inputs used in production, such as raw materials like coal and crude oil , intermediate products such as flour and steel, and finished machinery. In response, companies typically raise the prices of their products or services to offset inflation, meaning consumers absorb these price increases. For many companies, the trick is to strike a balance between raising prices to make up for input cost increases while simultaneously ensuring that they don’t rise so much that it suppresses demand, which is touched on later in this article.

How is inflation measured?

Statistical agencies measure inflation by first determining the current value of a “basket” of various goods and services consumed by households, referred to as a price index. To calculate the rate of inflation, or percentage change, over time, agencies compare the value of the index over one period to another, such as month to month, which gives a monthly rate of inflation, or year to year, which gives an annual rate of inflation.

For example, in the United States, that country’s Bureau of Labor Statistics publishes its Consumer Price Index (CPI), which measures the cost of items that urban consumers buy out of pocket. The CPI is broken down by regions and is reported for the country as a whole. The  Personal Consumption Expenditures (PCE) price index —published by the US government’s Bureau of Economic Analysis—takes into account a broader range of consumers’ expenditures, including healthcare. It is also weighted by data acquired through business surveys.

Introducing McKinsey Explainers : Direct answers to complex questions

What are the main causes of inflation.

There are two primary types, or causes, of inflation:

• Demand-pull inflation occurs when the demand for goods and services in the economy exceeds the economy’s ability to produce them. For example, when demand for new cars recovered more quickly than anticipated from its sharp dip at the beginning of the COVID-19 pandemic, an intervening shortage in the supply of semiconductors  made it hard for the automotive industry to keep up with this renewed demand. The subsequent shortage of new vehicles resulted in a spike in prices for new and used cars.
• Cost-push inflation occurs when the rising price of input goods and services increases the price of final goods and services. For example, commodity prices spiked sharply  during the pandemic as a result of radical shifts in demand, buying patterns, cost to serve, and perceived value across sectors and value chains. To offset inflation and minimize impact on financial performance, industrial companies were forced to consider price increases that would be passed on to their end consumers.

Learn more about McKinsey's Pricing  practice.

How does inflation today differ from historical inflation?

In January 2022, inflation in the United States accelerated to 7.5 percent, its highest level since February 1982, as a result of soaring energy costs , labor mismatches , and supply disruptions . But inflation is not a new phenomenon; countries have weathered inflation throughout history.

A common comparison to the current inflationary period is with that of the post–World War II era , when price controls, supply problems, and extraordinary demand fueled double-digit inflation gains—peaking at 20 percent in 1947—before subsiding at the end of the decade, according to the US Bureau of Labor Statistics. Consumption patterns today have been similarly distorted, and supply chains have been disrupted  by the pandemic.

The period from the mid-1960s through the early 1980s, sometimes called “The Great Inflation,” saw some of the highest rates of inflation, with a peak of 14.8 percent in 1980. To combat this inflation, the Federal Reserve raised interest rates to nearly 20 percent. Some economists attribute this episode partially to monetary policy mistakes rather than to other purported causes, such as high oil prices. The Great Inflation signaled the need for public trust in the Federal Reserve’s ability to lessen inflationary pressures.

How does inflation affect pricing?

When inflation occurs, companies typically pay more for input materials . One way for companies to offset losses and maintain gross margins is by raising prices for consumers, but if price increases are not executed thoughtfully, companies can damage customer relationships, depress sales, and hurt margins. An exposure matrix that assesses which categories are exposed to market forces, and whether the market is inflating or deflating, can help companies make more informed decisions.

Done the right way, recovering the cost of inflation for a given product can strengthen relationships and overall margins. There are five steps companies can take to ADAPT  (Adjust, Develop, Accelerate, Plan, and Track) to inflation:

• Adjust discounting and promotions and revisit other aspects of sales unrelated to the base price, such as lengthened production schedules or surcharges and delivery fees for rush or low-volume orders.
• Develop the art and science of price change . Don’t make across-the-board price changes; rather, tailor pricing actions to account for inflation exposure, customer willingness to pay, and product attributes.
• Accelerate decision making tenfold . Establish an “inflation council” that includes dedicated cross-functional, inflation-focused decision makers who can act nimbly and quickly on customer feedback.
• Plan options beyond pricing to reduce costs . Use “value engineering” to reimagine your portfolio and provide cost-reducing alternatives to price increases.
• Track execution relentlessly . Create a central supporting team to address revenue leakage and to manage performance rigorously.

Beyond pricing, a variety of commercial and technical levers can help companies deal with price increases in an inflationary market , but other sectors may require a more tailored response to pricing. In the chemicals industry, for instance, category managers contending with soaring prices of commodities can make the following five moves  to save their companies money:

• Gain a full understanding of supply–market dynamics and outlook . Understand and track the elements that trigger price increases and rescind these increases once those drivers are no longer applicable.
• Ensure that suppliers can clearly articulate the impact that price increases in the market have on suppliers’ prices . In times of upward price pressure, sellers often overstate the share of raw materials in input costs, taking the opportunity to inflate their margins. Using cleansheet methodology to identify and challenge these situations is important.
• View unavoidable price increases as temporary surcharges, not the new future state . This mechanism, partly psychological in nature, is very effective in dealing with the stickiness of price increases because it shifts the burden of proof to the supplier.
• Prioritize cross-functional initiatives . When prices are high, the impact of yield improvements, waste reduction, or substitutions can be amplified. If any are available, now is the time to make them a priority.
• Work with sales to pass on price increases . Category managers work closely with finance and commercial teams to shed light on pure market effects and their impact on the prices of goods sold, while ensuring that the right arguments are advanced to pass market-price increases to customers.

Learn more about our Financial Services , Advanced Electronics , Operations , and Growth, Marketing & Sales  practices.

What is the difference between inflation and deflation?

If inflation is one extreme of the pricing spectrum, deflation is the other. Deflation occurs when the overall level of prices in an economy declines and the purchasing power of currency increases. It can be driven by growth in productivity and the abundance of goods and services, by a decrease in aggregate demand, or by a decline in the supply of money and credit.

Generally, moderate deflation positively affects consumers’ pocketbooks, as they are able to purchase more with less money. However, deflation can be a sign of a weakening economy, leading to recessions and depressions. While inflation reduces purchasing power, it also reduces the value of debt. During a period of deflation, on the other hand, debt becomes more expensive. Additionally, consumers can protect themselves to an extent during periods of inflation. For instance, consumers who have allocated their money into investments can see their earnings grow faster than the rate of inflation. During episodes of deflation, however, investments, such as stocks, corporate bonds, and real-estate investments, become riskier.

A recent period of deflation in the United States occurred between 2007 and 2008, referred to by economists as the Great Recession. In December 2008, more than half of executives surveyed by McKinsey  expected deflation in their countries, and 44 percent expected to decrease the size of their workforces.

When taken to their extremes, both inflation and deflation can significantly and negatively affect consumers, businesses, and investors.

For more in-depth exploration of these topics, see McKinsey’s Operations Insights  collection. Learn more about Operations consulting , and check out operations-related job opportunities if you’re interested in working at McKinsey.

Articles referenced include:

• “ How business operations can respond to price increases: A CEO guide ,” March 11, 2022, Andreas Behrendt , Axel Karlsson , Tarek Kasah, and Daniel Swan
• “ Five ways to ADAPT pricing to inflation ,” February 25, 2022, Alex Abdelnour , Eric Bykowsky, Jesse Nading, Emily Reasor , and Ankit Sood
• “ How COVID-19 is reshaping supply chains ,” November 23, 2021, Knut Alicke , Ed Barriball , and Vera Trautwein
• “ Navigating the labor mismatch in US logistics and supply chains ,” December 10, 2021, Dilip Bhattacharjee , Felipe Bustamante, Andrew Curley, and Fernando Perez
• “ Coping with the auto-semiconductor shortage: Strategies for success ,” May 27, 2021, Ondrej Burkacky , Stephanie Lingemann, and Klaus Pototzky

Want to know more about inflation?

Related articles.

What is supply chain?

How business operations can respond to price increases: A CEO guide

Five ways to ADAPT pricing to inflation

• SUGGESTED TOPICS
• The Magazine
• Newsletters
• Managing Yourself
• Managing Teams
• Work-life Balance
• The Big Idea
• Data & Visuals
• Reading Lists
• Case Selections
• HBR Learning
• Topic Feeds
• Account Settings
• Email Preferences

What Causes Inflation? 

• Walter Frick

Why your money is worth less than it used to be.

What causes inflation? There is no one answer, but like so much of macroeconomics it comes down to a mix of output, money, and expectations. Supply shocks can lower an economy’s potential output, driving up prices. An increase in the money supply can stoke demand, driving up prices. And the expectation of inflation can become a self-fulfilling cycle as workers and companies demand higher wages and set higher prices.

Since the financial crisis of 2008 and the Great Recession, investors and executives have grown accustomed to a world of low interest rates and low inflation. No longer. In 2021, inflation began rising sharply in many parts of the world, and in 2022 the U.S. saw its worst inflation in decades.

• Walter Frick is a contributing editor at Harvard Business Review , where he was formerly a senior editor and deputy editor of HBR.org. He is the founder of Nonrival , a newsletter where readers make crowdsourced predictions about economics and business. He has been an executive editor at Quartz as well as a Knight Visiting Fellow at Harvard’s Nieman Foundation for Journalism and an Assembly Fellow at Harvard’s Berkman Klein Center for Internet & Society. He has also written for The Atlantic , MIT Technology Review , The Boston Globe , and the BBC, among other publications.

Partner Center

Home — Essay Samples — Economics — Political Economy — Inflation

Essays on Inflation

Inflation essay topics and outline examples, essay title 1: understanding inflation: causes, effects, and economic policy responses.

Thesis Statement: This essay provides a comprehensive analysis of inflation, exploring its root causes, the economic and societal effects it generates, and the various policy measures employed by governments and central banks to manage and mitigate inflationary pressures.

• Introduction
• Defining Inflation: Concept and Measurement
• Causes of Inflation: Demand-Pull, Cost-Push, and Monetary Factors
• Effects of Inflation on Individuals, Businesses, and the Economy
• Inflationary Policies: Central Bank Actions and Government Interventions
• Case Studies: Historical Inflationary Periods and Their Consequences
• Challenges in Inflation Management: Balancing Growth and Price Stability

Essay Title 2: Inflation and Its Impact on Consumer Purchasing Power: A Closer Look at the Cost of Living

Thesis Statement: This essay focuses on the effects of inflation on consumer purchasing power, analyzing how rising prices affect the cost of living, household budgets, and the strategies individuals employ to cope with inflation-induced challenges.

• Inflation's Impact on Prices: Understanding the Cost of Living Index
• Consumer Behavior and Inflation: Adjustments in Spending Patterns
• Income Inequality and Inflation: Examining Disparities in Financial Resilience
• Financial Planning Strategies: Savings, Investments, and Inflation Hedges
• Government Interventions: Indexation, Wage Controls, and Social Programs
• The Global Perspective: Inflation in Different Economies and Regions

Essay Title 3: Hyperinflation and Economic Crises: Case Studies and Lessons from History

Thesis Statement: This essay explores hyperinflation as an extreme form of inflation, examines historical case studies of hyperinflationary crises, and draws lessons on the devastating economic and social consequences that result from unchecked inflationary pressures.

• Defining Hyperinflation: Thresholds and Characteristics
• Case Study 1: Weimar Republic (Germany) and the Hyperinflation of 1923
• Case Study 2: Zimbabwe's Hyperinflationary Collapse in the Late 2000s
• Impact on Society: Currency Devaluation, Poverty, and Social Unrest
• Responses and Recovery: Stabilizing Currencies and Rebuilding Economies
• Preventative Measures: Policies to Avoid Hyperinflationary Crises

The Impact of Inflation Reduction Act on The International Economic Stage

Inflation reduction act in the frame of macroeconomic challenges, made-to-order essay as fast as you need it.

Each essay is customized to cater to your unique preferences

+ experts online

Exploring The Implications of The Inflation Reduction Act

Report on inflation and its causes, the rise of inflation rate in the us, iflation and its causes, let us write you an essay from scratch.

• 450+ experts on 30 subjects ready to help
• Custom essay delivered in as few as 3 hours

Methods to Control Inflation

The grade inflation, inflation: a deceitful solution to debt, how to control inflation in pakistan, get a personalized essay in under 3 hours.

Expert-written essays crafted with your exact needs in mind

Main Factors of Inflation in Singapore

Effects of inflation on commercial banks’ lending: a case of kenya commercial bank limited, food inflation in the republic of india, the issue of unemployment and inflation in colombia, the theory and policy of macroeconomics on inflation rate, socio-economic conditions in 'what is poverty' by jo goodwin parker, non-accelerating inflation rate of unemployment (nairu), targeting zero inflation and increase of government spending as a way of curbing recession, howa spiraling inflation has impacted the venezuelan economy, how venezuela has been affected by inflation, effects of inflation on kenya commercial banks lending, exploring theories of inflation in economics, about fuel prices: factors, impacts, and solutions, analyzing the inflation reduction act, the oscillating tides of the american economy, relevant topics.

• Unemployment
• Penny Debate
• Supply and Demand
• Real Estate
• American Dream
• Minimum Wage

By clicking “Check Writers’ Offers”, you agree to our terms of service and privacy policy . We’ll occasionally send you promo and account related email

No need to pay just yet!

We use cookies to personalyze your web-site experience. By continuing we’ll assume you board with our cookie policy .

• Instructions Followed To The Letter
• Deadlines Met At Every Stage
• Unique And Plagiarism Free

• Skip to main content
• Keyboard shortcuts for audio player

Planet Money

• LISTEN & FOLLOW
• Apple Podcasts
• Google Podcasts
• Amazon Music

Your support helps make our show possible and unlocks access to our sponsor-free feed.

How bad is inflation?

Stacey Vanek Smith

Julia Ritchey

Darian Woods

Inflation is at a 40-year high, and this has impacted everything – from raises at work, to trips to the grocery store. Today, two stories from The Indicator on how rising prices have affected the economy, and what can be done about it.

We follow an UberEats driver and Instacart shopper who's seen her paycheck go up. But she's also seen rising prices for food, gas, and other basics that eat away at her income. So, has she gotten a real raise, or is it just an illusion? And we break down how the Federal Reserve is planning to fight inflation with one primary tool: interest rates.

Music: " Natural Time Cycles ," " Sneaky Love ," " No Fomo Instrumental " and " Waking Up To The Fire ."

Find us: Twitter / Facebook / Instagram / TikTok

Subscribe to our show on Apple Podcasts , Spotify ; and NPR One .

Want economics stories from the comfort of home? Subscribe to Planet Money's weekly newsletter .

Economic essays on inflation

• Definition – Inflation – Inflation is a sustained rise in the cost of living and average price level.
• Causes Inflation – Inflation is caused by excess demand in the economy, a rise in costs of production, rapid growth in the money supply.

• Costs of Inflation – Inflation causes decline in value of savings, uncertainty, confusion and can lead to lower investment.

• Problems measuring inflation – why it can be hard to measure inflation with changing goods.
• Different types of inflation – cost-push inflation, demand-pull inflation, wage-price spiral,
• How to solve inflation . Policies to reduce inflation, including monetary policy, fiscal policy and supply-side policies.
• Trade off between inflation and unemployment . Is there a trade-off between the two, as Phillips Curve suggests?
• The relationship between inflation and the exchange rate – Why high inflation can lead to a depreciation in the exchange rate.
• What should the inflation target be? – Why do government typically target inflation of 2%
• Deflation – why falling prices can lead to negative economic growth.
• Monetarist Theory – Monetarist theory of inflation emphasises the role of the money supply.
• Criticisms of Monetarism – A look at whether the monetarist theory holds up to real-world scenarios.
• Money Supply   – What the money supply is.
• Can we have economic growth without inflation?
• Predicting inflation
• Link between inflation and interest rates
• Should low inflation be the primary macroeconomic objective?

See also notes on Unemployment

An economist explains: What you need to know about inflation

Assistant Professor, Department of Economics, Toronto Metropolitan University

Disclosure statement

Nicholas Li does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

Toronto Metropolitan University provides funding as a founding partner of The Conversation CA.

Toronto Metropolitan University provides funding as a member of The Conversation CA-FR.

View all partners

• Bahasa Indonesia

Inflation is one of the most pressing political and economic issues of the moment, but there are many misconceptions about how inflation is measured, where it comes from and how it impacts the average person.

In June, inflation in Canada reached a 40-year high of 8.1 per cent . While there are signs inflation may be moderating , many Canadians have dealt with the surging cost of living by cutting back on expenses , working more to increase their income, drawing on their savings or taking on more debt .

As an economics professor who conducts research on prices and consumption, I would like to provide some insight into how inflation is measured and how it is impacting Canadians and the economy at large.

What is inflation?

Inflation refers to a general increase in prices and the resulting decline in the purchasing power of money. While most of us can sense whether inflation is high or low from everyday purchases, the inflation rate that gets reported in the press and discussed by policy-makers is a specific measure created by a small army of statisticians and data collectors.

Statistics Canada constructs the Consumer Price Index (CPI) used to track inflation through a two-step process. In the first step, Statistics Canada collects over one million price quotes on virtually anything purchasable in the country.

Prices are recorded in a variety of ways, and the frequency and geography of price collection depends on the item. For example, items with prices that change quickly like food or gasoline, or vary across locations like rent, are collected more frequently than items that are collected once a year, like university tuition or insurance rates.

In the second step, Statistics Canada aggregates these prices to generate the all-item Consumer Price Index by weighing each item’s price change by its share of total consumer spending. These weights are occasionally updated to reflect changes in consumer spending patterns .

The most recent update in 2021 reflects some pandemic-related spending changes, such as a lower weight for food (15.75 per cent) and transportation (16.16 per cent), but a higher weight for shelter (29.67 per cent).

Statistics Canada and the Bank of Canada also measure “ core inflation ” which removes items with the most volatile prices (food and energy) from the CPI to provide a better sense of slower-moving, long-term cost pressures.

What causes inflation?

Prices are determined by supply and demand . High inflation is a sign that, across the economy, demand for goods and services exceeds their supply.

Demand has been strong due to strong employment and wage growth , cheap credit , pandemic-related payments from governments and pandemic-related shifts in demand towards goods consumed at home .

Supply has been disrupted by the pandemic’s effects on Chinese factories , international supply chains , container shipping , trucking and the Russian invasion of Ukraine that led to recent spikes in food and energy prices around the world.

Inflation feels higher than it is

Many Canadians feel like prices rose by more than 8.1 per cent in the last year. Beyond specific criticism of the CPI methodology in Canada , there are at least two reasons for this.

First, consumer spending is measured through surveys that capture the diversity of spending patterns in the population, but collapse this diversity into a single set of weights that treats each dollar of spending equally. Spending patterns vary with age, income, location, household composition and taste, and your personal budget might bear little resemblance to the weights used for the CPI.

Second, we are more likely to notice price changes for items we purchase frequently , and we tend to notice price increases more than decreases . The items with the highest price increases in the last year — energy and food — have these characteristics, and we are less likely to notice the (lower) inflation rate for furniture, electronics, education and health goods that balance these out.

We also pay a lot of attention to soaring house prices and interest rates — especially in big cities — but the cost of owned accommodation in the CPI is based on historical averages of housing prices (25 years) and interest rates (five years) that reflect long-term financing costs for the average homeowner, not someone buying a house today.

How does inflation impact us?

There are winners and losers when it comes to inflation. While it can hurt businesses that end up passing cost increases onto their customers , it can benefit others by allowing them to raise their prices without customer backlash because “everyone else is doing it.”

High inflation is often, but not always, accompanied by high wage growth . Individuals who earn no or below-inflation wages are hurt, while individuals with wages indexed to inflation or who are able to negotiate better wages can benefit. Individuals like seniors on fixed incomes are often hurt by inflation, although many government benefits are indexed to inflation .

Some asset prices are better at keeping pace with inflation. Prices of housing, stocks, art and precious metals may go up, while assets with fixed dollar values like cash and bonds do not.

Inflation can make it easier to repay debts, as long as wages or other asset prices keep pace. Inflation can also benefit government finances as tax revenues rise relative to the dollar value of the debt.

While the source of our current inflation is irrelevant to consumers, it matters for economic policy. Central banks and governments must decide whether to curb demand and risk recession by raising interest rates , cutting spending or raising taxes, or wait and hope that supply-side inflation pressures ease up on their own.

We can only hope that it will not take a major recession to end this period of high inflation (unlike the last major effort by the Bank of Canada to lower inflation ) and that Canada avoids “ stagflation ,” the combination of high inflation and high unemployment that afflicted many economies in the late 1970s.

• Supply and demand
• Cost of living
• Consumer price index (CPI)
• Economic crisis
• Statistics Canada
• Consumer Price Index
• Listen to this article
• Cost of living crisis

Biocloud Project Manager - Australian Biocommons

Director, Defence and Security

Opportunities with the new CIEHF

School of Social Sciences – Public Policy and International Relations opportunities

Deputy Editor - Technology

Is Inflation on the Way Out or Here to Stay?

Since March 2021, inflation has been above the Federal Reserve’s 2% target. After peaking in June 2022, inflation—measured as the 12-month change in the personal consumption expenditures (PCE) price index—trended steadily downward for a year. This decline reversed in July and August 2023, though some other measures of inflation continued to fall. Regardless of how we measure it, inflation remains high.

Do these developments signal the end of high inflation is nigh, or will inflation instead settle at rates higher than in the period prior to the COVID-19 pandemic? In this blog post, I will provide relevant evidence to shed light on this debate, which is central to future monetary policy. In addition, the Bureau of Economic Analysis (BEA) recently published a comprehensive update to the national accounts , so this provides a good opportunity to take a renewed look at the data. This blog post is part of a series that started in April 2021 with “Is Inflation Making a Comeback?” ; my most recent posts this year were the May 8 post "Understanding the Recent Behavior of Inflation" and the May 9 post "Where Might Inflation Head?"

The Overall Inflation Picture

Inflation is the change in the price level over a period of time. The Federal Reserve’s preferred measure for the price level is the PCE price index, as published by the BEA. The Federal Reserve also pays close attention to core PCE inflation, i.e., excluding the contribution of food and energy prices, which tend to be very volatile and largely determined by external factors. Core inflation is thus deemed more informative about underlying inflation trends. Note, however, that recent experience and some research  have cast doubt on the appropriateness of excluding food.

The figure below shows inflation rates, measured as the 12-month change in the price index. It includes three measures: one that includes all consumption items (headline), one that excludes energy, and one that excludes both food and energy (core).

Annualized Inflation Rates

SOURCES: Bureau of Economic Analysis and Haver Analytics.

All three measures of inflation increased significantly since March 2021 and have remained well above 2% annual. Clearly, energy prices contributed to inflation dynamics, making the initial rise in inflation and its subsequent fall more pronounced. The recent increase in energy prices contributed to a reversal in the decline of headline inflation and will likely contribute upward pressure in the months to come. By comparing the series excluding energy and the core series, we can also see the contribution of food to overall inflation during 2022.

Focusing on core goods and services, inflation was below the Federal Reserve’s target in the years prior to the pandemic, averaging 1.7% annual between 2016 and 2019. It remained close to that average during the initial year of the pandemic and then jumped to 5.2% annual in 2021 and 4.9% annual in 2022. So far, the annualized inflation rate for core goods and services in 2023 is 3.6%, lower than in preceding years but still well above the target.

What Are the Key Components Driving Inflation?

The table below decomposes inflation into five major categories: food, energy, core goods, core services excluding housing, and housing. The contribution of these components in total consumption expenditures is, roughly, 8%, 4%, 22%, 50% and 16%, respectively. The table measures inflation rates over various periods of interest. The first, 2016-2019, represents the years immediately prior to the pandemic. Next are the years 2020, 2021, 2022 and, finally, 2023 up to August, the latest date available. All inflation rates are annualized to make them comparable across periods of different length.

The table shows that inflation varies significantly across these broad categories. Prior to the pandemic, food prices were stable, and core goods prices were declining, while core services excluding housing and housing were both growing above the Federal Reserve’s target rate. When combined, these numbers implied an overall inflation rate of 1.6% annually, which is below the target.

All categories contributed to the high overall inflation in 2021 and 2022. So far in 2023, inflation in food, energy and core goods has decelerated markedly, falling below 2% at annual rates. In contrast, inflation in core services excluding housing and in housing decelerated but remain well above 2% annual. Core services, which includes housing, represent two-thirds of consumption expenditures. Hence, inflation in this category will have to fall substantially more before overall inflation can be sustained close to target.

How Widespread Is Inflation?

We can further inspect the distribution of inflation across individual product categories. The disaggregated data published by the BEA consist of 244 product categories with monthly series on expenditures, prices and real quantities. For each product category, I computed the annualized price change and the expenditure share in each period. The figure below estimates the distribution of inflation for 2021, 2022 and 2023 (up to August) across product categories, with annualized price changes on the horizontal axis and the corresponding expenditure shares on the vertical axis. For a full description of the methodology, see my Oct. 19, 2021, blog post  “How Widespread Are Price Increases in the U.S.?”

Estimated Distribution of Annualized PCE Inflation

SOURCES: Bureau of Economic Analysis and author’s calculations.

NOTES: Distributions are computed with kernel density estimation in Stata, using the optimal bandwidth for each period. The 2023 period is the year through August.

So far, the distribution of inflation across product categories in 2023 seems to be somewhere in between the previous two years, but with important differences. Notably, the contribution of outliers to overall inflation is not as significant in 2023 as in previous years; that is, the share of expenditures in items experiencing high inflation rates is now much smaller. Furthermore, about one-fifth of consumption expenditures are in categories experiencing deflation, which contributes to the decline in overall inflation. Had the price of these products remained constant rather than declined, annualized inflation for 2023 through August would have been 0.8 percentage points higher.

The Effects of the Pandemic and Monetary Policy on Consumption

When the pandemic hit in 2020, the Federal Reserve lowered its policy rate to near zero, among other measures designed to support the economy. Beginning in March 2022, as high inflation endured, the Federal Reserve embarked on a series of rapid and sustained increases in the policy rate. As of August 2023, the federal funds rate and the yields on Treasuries at all maturities were above the inflation rate.

When interest rates rise, the demand for consumption is pressured downward, as higher rates make consumer financing more costly and increase the incentives to save. Lower demand then leads to lower inflationary pressures as producers and sellers find it more difficult to hike their prices. What was the response of consumption to the pandemic, inflation and monetary policy?

The figure below shows monthly consumption expenditures, measured in 2017 dollars, as well as their pre-pandemic trend.

Monthly Real Consumption

Real consumption dropped significantly at the onset of the pandemic and took until March 2021 to return to its pre-pandemic trend. Since then, real consumption has remained persistently above trend, just like inflation and despite high interest rates. The boom in real consumption is mainly driven by expenditures on goods, as services have remained below trend though they have almost caught up.

If we take the difference between actual real consumption and its pre-pandemic trend, we get an accumulated consumption deficit of $375 billion (in 2017 prices) since the start of the pandemic. This deficit represents $455 billion in current prices or about a third of monthly consumption.

There are then two opposing forces operating on consumer demand and hence inflation. On the one hand, higher interest rates disincentivize consumption as they promote saving and increase financing costs. On the other hand, consumers may still desire to make up for past privations, especially on services. The ability of households to self-finance consumption affects how these two forces are balanced.

Households Still Hold Excess Personal Savings

Personal savings are defined as disposable personal income minus personal outlays. Before the pandemic, disposable income was growing at a faster rate than outlays. Hence, personal savings had a trend, which is calculated for the years 2016-2019. We then subtract this trend from actual savings to obtain a measure of excess savings. Next, we sum these excess savings to get a measure of accumulated excess savings, as shown in the figure below. Note that excess savings were computed in nominal terms, i.e., in current dollars.

This figure also shows a measure of excess inflation. Specifically, it displays the series of PCE inflation excluding energy (as shown in the first figure) minus the 2% inflation target. As we can see, excess inflation was actually negative in the years prior the pandemic, when PCE inflation excluding energy was averaging 1.6% annually.

Accumulated Excess Personal Savings and Excess Inflation

NOTES: Personal savings are defined as disposable personal income minus personal outlays. Excess personal savings are computed by subtracting the 2016-2019 trend. Accumulated excess personal savings are the sum of excess personal savings since January 2016. Excess inflation is defined as the annual growth rate of the PCE price index excluding energy minus 2%.

Until the onset of the pandemic, excess savings averaged zero as both personal disposable income and outlays grew very close to their respective trends. During the pandemic, the federal government implemented three big rounds of assistance, mainly consisting of direct transfers to individuals and other forms of support that eventually made their way to households.

Accumulated excess personal savings peaked at $2.2 trillion in August 2021 and have been declining ever since. However, they still stood at over $600 billion as of August 2023. This is $150 billion more than the consumption deficit I computed above. In other words, despite the curbing incentives provided by higher interest rates, households on average have the capacity to continue consuming above trend in real terms and more than make up for pandemic-related privations.

As we can see, excess inflation traces accumulated excess savings closely but with a few months’ delay. This underscores the tight connection between fiscal policy during the pandemic and the subsequent inflation. For an articulation of economic theories connecting fiscal policy to inflation, as well as the risks for persistently high inflation surfacing at the time, see my Oct. 7, 2021, post “What Are the Risks for Future Inflation?”   For example, excess savings first jumped in April 2020, with the transfers due to the Coronavirus Aid, Relief and Economic Security (CARES) Act, while inflation took off several months later. (As mentioned above and shown in the figure, inflation crossed 2% annually in March 2021). Also, accumulated excess savings peaked in August 2021, while excess inflation peaked in September 2022.

Both excess savings and excess inflation have trended down steadily since reaching their peaks, inflation a bit faster than savings, likely due to tighter monetary policy. If these recent trends were to persist, both excesses will have vanished by the end of the first half of 2024. That is, by June 2024 accumulated excess savings will have been depleted, while inflation will have fallen to 2% annually.

The Road Ahead

To recap, inflation has slowed during 2023, after two years at elevated levels, but it remains well above the Federal Reserve’s 2% target. Deflation in certain goods has helped bring average inflation down. In contrast, inflation in core services remains an item of concern as it has yet to show a marked and sustained deceleration.

Despite the Federal Reserve’s policy of high interest rates, real consumption has remained above trend, though there is still a deficit of consumption from the pandemic. Excess personal savings, boosted by fiscal policy during the pandemic, have been declining slowly but remain high enough to finance above-trend consumption, undermining the effects of tighter monetary policy.

The question remains: Will inflation continue to glide down toward 2%, or will it settle at rates above it? The latter scenario is particularly troublesome as experiencing inflation persistently above the target may erode the Federal Reserve’s credibility, which is an essential tool in the successful conduct of monetary policy.

The so-called “higher for longer” policy—that is, maintaining interest rates high even as inflation declines—is intended to ensure that the mechanism by which high interest rates curb consumption remains active until inflation is successfully brought down to the 2% target. Recent data on output and expectations of future growth have been revised upward, while the unemployment rate has remained near historic lows. These factors have provided the Federal Reserve with enough cover to focus on its fight against high inflation. They have also contributed to the recent rise of long-term interest rates. Ultimately, it is long-term interest rates (e.g., mortgage rates) that most affect consumer behavior and thus are a crucial transmission mechanism for monetary policy.

Several risks remain that could delay or potentially reverse the decline in inflation. First, energy prices have again surged, with oil currently trading at prices similar to those in late 2022. This reversal will likely arrest the momentum in headline inflation and may adversely affect inflation expectations should this rally persist.

Second, inflation in services remains stubbornly high. A simple calculation illustrates the importance of this fact. Suppose the price of goods remains constant while the price of services continues growing at its 2023 annualized rate (4.2% annual). Then, inflation for 2023 ends up at 3.2%. That is, the momentum of inflation in services is enough to keep overall inflation above target. There is the additional risk that, should this momentum persist, services may drag inflation in goods upward, rather than the other way around, as consumers coordinate their expectations on higher inflation.

Third, preliminary estimates indicated that the federal deficit was $1.7 trillion in fiscal year 2023, roughly $300 billion more than in 2022. See the Congressional Budget Office’s September budget review . Consequently, debt in the hands of the public increased by about $2.2 trillion in 2023. The debt is expected to continue growing over the next decade and beyond. An outsized increase in government liabilities, particularly when used to support direct transfers to individuals as was the case during the pandemic, may lead to a sharp rise in prices. Though the effects of pandemic expenditures are dying out, as evidenced by the slow but steady decline in excess savings, persistent large deficits may again put upward pressure on future inflation.

• This blog post is part of a series that started in April 2021 with “ Is Inflation Making a Comeback? ”; my most recent posts this year were the May 8 post “ Understanding the Recent Behavior of Inflation ”; and the May 9 post “ Where Might Inflation Head? ”
• For a full description of the methodology, see my Oct. 19, 2021, blog post “ How Widespread Are Price Increases in the U.S.? ”
• For an articulation of economic theories connecting fiscal policy to inflation, as well as the risks for persistently high inflation surfacing at the time, see my Oct. 7, 2021, post “ What Are the Risks for Future Inflation? ”
• See the Congressional Budget Office’s September budget review .

Fernando M. Martin is an economist and senior economic policy advisor at the Federal Reserve Bank of St. Louis. His research interests include macroeconomics, monetary economics, banking and public finance. He joined the St. Louis Fed in 2011.  Read more about the author and his research .

Related Topics

This blog offers commentary, analysis and data from our economists and experts. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.

Media questions

All other blog-related questions

Inflation and the gap between economic performance and economic perceptions

Subscribe to governance weekly, william a. galston william a. galston ezra k. zilkha chair and senior fellow - governance studies.

March 25, 2024

• There is modest but inconclusive evidence supporting a link between poor evaluations of the current economy and variables such as economic inequality, the rise of conspiracy theories, economic insecurity, and negative expectations about the economic future.
• The apparent gap between economic conditions and public attitudes disappears when voters’ perceptions of what is most important about the economy are taken into account.
• History suggests that economic perceptions lag well behind changes in economic conditions.

Many Biden administration officials and sympathetic analysts are baffled by what they see as a huge gap between negative public sentiment about the economy and its actual performance. They do not understand why supermajorities rate the condition of the economy as “only fair” or “poor” and trust former President Trump more than President Biden to steward the economy over the next four years. After all, Biden supporters rightly insist, GDP growth averaged a robust 3.4% annually during Biden’s first three years, compared to 2.7% for Trump’s. Between January 2021 and January 2024, employment grew by more than 11 million, unemployment fell by four million, and the unemployment rate plunged from 6.3% to 3.7%. In fact, unemployment has remained below four percent for two full years, the longest in history. Biden’s first three years witnessed the creation of 791,000 manufacturing jobs, almost twice the number during Trump’s first three years, and Black unemployment hit a historic low of 4.8%.

Faced with the disconnect between these figures and public opinion, economists and political scientists have explored several hypotheses to explain the gap. There is modest but inconclusive evidence supporting a link between poor evaluations of the current economy and variables such as economic inequality, the rise of conspiracy theories, economic insecurity, and negative expectations about the economic future.

Two other potential explanations for the gap are more promising. First, Brookings scholars Ben Harris and Aaron Sojourner have documented a rise of negative news coverage of the economy , corrected for underlying conditions, since 2018, and they cite a growing body of literature finding a link between the tone of news coverage and measures of consumer sentiment. They acknowledge, however, that the direction of causation is not entirely clear: “Are consumers more negative about the economy because of the news,” they ask, “or is the news reporting more negative stories to match consumers’ beliefs?” Further complicating the picture, they note that the gap between news reports and economic conditions has closed in recent months. While it seems likely that news coverage would have some effect on economic sentiments, the size of this effect is difficult to measure without additional research.

A second line of explanation seems more promising. In an article by a distinguished team of political scientists, David Brady, John Ferejohn, and Brett Parker explore the influence of partisanship on voters’ evaluations of the economy. To no one’s surprise, they find that partisan affiliations do influence economic perceptions. More significantly, they find that the impact of partisanship on economic attitudes has doubled since 2001, consistent with the intensification of partisan polarization during this period. They also find “no evidence” that Republicans are more responsible than Democrats for the growing gap in economic perceptions (or vice versa).

This does not mean that economic sentiments are driven entirely by political affiliations. Although the impact of affiliation has grown substantially, diminishing the accuracy of economic models of voting behavior, models using economic as well as political variables are better predictors than those that take only politics into account.

This returns us to the initial question—the apparent gap between economic conditions and public attitudes. I want to offer a dissenting hypothesis: The gap disappears when voters’ perceptions of what is most important about the economy are taken into account. Numerous surveys have shown that voters regard inflation as the single most important indicator of how the economy is doing—and that they are more likely to define inflation as the level of prices (high or low) rather than the pace of price increases (fast or slow). Prices have risen by 18% during Biden’s first three years in office, compared to 6.2% during Trump’s first three years . Voters notice the difference, and it matters to them.

Why it matters becomes clear when we look at specific goods and services . Since January of 2021, rents have risen by 19.5%; used cars, trucks, and meat by 20%; restaurants and groceries by 21%; airfares by 23.5%; electricity by 28%; gas by 34.6%; eggs by 37.4%; and auto insurance by 44%.

Is it irrational for voters to give much more weight to inflation than to unemployment in assessing economic conditions? Not necessarily, for several reasons. First, inflation leads to higher interest rates, raising the cost of home mortgages, auto loans, and credit card debt. An important new paper finds that including interest rates in the cost of living dramatically reduces the gap between consumer sentiment and economic conditions.

Second, inflation dilutes—and can negate—the impact of rising nominal wages. During Biden’s first three years, average wages for non-supervisory workers rose by 15.4%, but the 18% increase in prices led to a reduction of 2.6% in purchasing power. By contrast, wages rose by 9.3% during Trump’s first three years, yielding a 3.1% increase in purchasing power. Similarly, median household income, corrected for inflation, rose by 10.5% during Trump’s first three years. (The increase for Hispanic households was even larger—11.7%—which may help explain the apparent shift of these households toward Trump.) Although the Census Bureau has not yet reported on household income for 2023, the reports for Biden’s first two years in office —2021 and 2022—show a decline of 2.3%.

Third, less tangibly but not necessarily less significantly, there is evidence from previous periods in the United States and elsewhere that inflation has a symbolic meaning, a broader sense of loss of control. In an Economist/YouGov poll released in early February, only 17% of respondents felt that things in the country these days are “under control,” compared to 66% who said that they were “out of control.”

Finally, unlike unemployment, inflation directly affects everyone. It erodes not only wages and incomes but also the value of savings and retirement funds. It hits lower-income and working-class households, who live close to the margin and must devote a higher share of their income to the basics—rent, food, electricity, and transportation—especially hard.

Defenders of the Biden administration’s economic record note—correctly—that the period of price increases outrunning wages ended in the spring of 2023 and that the past year has witnessed substantial increases in real incomes. But history suggests that economic perceptions lag well behind changes in economic conditions. For example, the recession that began in July 1990 during the presidency of George H. W. Bush officially ended in the spring 1991, but Bill Clinton nevertheless ran successfully against Bush’s economic record 18 months later, in the fall of 1992. Even if the rate of inflation continues to decline while wages and incomes increase, President Biden is in a race against time for voters’ economic sentiments to shift in his favor by Election Day. More favorable news coverage may help, but deep partisan divisions may mute the electoral impact of economic improvements, as they have increasingly since the beginning of the 21st century.

Related Content

William G. Gale

March 13, 2024

William A. Galston

March 8, 2024

William A. Galston, Jon Valant, Chinasa T. Okolo, E.J. Dionne, Jr., Bill Baer

March 6, 2024

Economic Indicators

Campaigns & Elections Political Parties Political Polarization

Governance Studies

U.S. States and Territories

Center for Effective Public Management

Election ’24: Issues at Stake

March 28, 2024

Ben Harris, Aaron Sojourner

December 4, 2023

February Inflation Report Consumer Price Increases Inch Higher

Inflation ran at 3.2 percent in the year through February, faster than expected, and a sign that inflation could prove difficult to fully stamp out.

• Share full article

Year-over-year change in the Consumer Price Index through February 2024

Jeanna Smialek

Inflation ticked up last month, backing the Fed’s caution on rate cuts.

Inflation sped up slightly in February on an overall basis and a closely watched measure of underlying price increases was firmer than economists had expected.

The fresh data underscore that fully returning inflation back to a normal pace is likely to be a bumpy process — and back up the Federal Reserve’s decision to proceed carefully as officials consider when and how much to lower interest rates.

The Consumer Price Index climbed 3.2 percent last month from a year earlier, up from 3.1 percent in January. That’s down notably from a 9.1 percent high in 2022, but it is still quicker than the roughly 2 percent that was normal before the 2020 pandemic.

After stripping out volatile food and fuel costs for a better sense of the underlying trend, inflation came in at 3.8 percent, slightly faster than economists had forecast. And on a monthly basis, core inflation climbed slightly more quickly than anticipated as airline fares and car insurance prices increased, even as one closely watched housing measure climbed less rapidly.

Taken as a whole, the report was the latest sign that bringing inflation fully down is likely to take time and patience.

“It just is going to underscore the Fed’s cautiousness regarding the inflation outlook,” said Kathy Bostjancic, chief economist at Nationwide Mutual.

To date, inflation has come down steadily and relatively painlessly: Unemployment continues to hover below 4 percent and growth in 2023 was unexpectedly strong, even though the Fed has raised interest rates to a more than two-decade high.

Fed officials have been debating how long they need to leave rates at their current level, about 5.3 percent. Elevated borrowing costs make it expensive for people to borrow to buy a house or expand a business, and that can weigh on the economy over time. The Fed has been trying to tamp down demand enough to bring inflation under control, but officials want to avoid crushing growth to the point that it leads to widespread job losses or a recession.

Some economists have been worried that it could be harder to slow inflation the rest of the way than it has been to achieve the progress so far. And Fed officials want to avoid lowering interest rates too early, only to find out that inflation is not fully quashed.

“We don’t want to have a situation where it turns out that the six months of good inflation data we had last year didn’t turn out to be an accurate signal of where underlying inflation is,” Jerome H. Powell, the Fed chair, said while testifying before Congress last week . Given that, he said, the Fed is being careful.

But Mr. Powell also said last week that when the Fed was confident that inflation had come down enough, “and we’re not far from it,” then it would be appropriate to lower interest rates.

“Overall, the view that disinflation is in the economy — that is still intact,” Ms. Bostjancic said following the fresh inflation report. “But it keeps them in a wait-and-see mode to really have that confidence that they should start cutting rates.”

The Fed aims for 2 percent yearly inflation. It defines that goal using a separate but related inflation index, the Personal Consumption Expenditures measure. That index incorporates some data from the Consumer Price Index figures, but comes out at more of a delay.

Some economists have questioned whether price increases will continue to fade smoothly toward the central bank’s target. If inflation for services — things like housing and insurance — proves more stubborn than expected, it could make overall price increases more difficult to fully stamp out.

The report released on Tuesday offered some good news in that regard. A closely watched measure that effectively tracks how much it would cost to rent a house that someone owns climbed more moderately. Economists had been nervously eyeing that “ owners’ equivalent rent ” measure after it accelerated in January.

Rent of primary residences, on the other hand, climbed slightly more quickly, at 0.5 percent on a monthly basis, compared with 0.4 percent in January.

“It had fallen so much the prior month that I’m not concerned at all about the rebound,” Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, said of the rent pickup. She said that together, the rent and owner’s rent measures were “telling a story of moderating shelter costs.”

Goods have been subtracting from inflation lately, but there were some exceptions in February. Apparel prices had been sinking recently on a monthly basis, for instance, but rose in cost last month.

Fed officials meet next week, on March 19-20, and are widely expected to leave interest rates unchanged at that gathering. They will release a new set of economic projections following the meeting, and those will show how much they expect to lower interest rates in 2024. As of their last estimates, published in December, officials had expected to make three interest rate cuts this year.

Investors think the Fed could begin lowering interest rates in June, later than they had anticipated earlier this year.

“We still believe there is plenty of disinflationary pressure to feed through,” economists at Capital Economics wrote in a note reacting to the report. They still think the Fed will start cutting rates in June, “by which time there will be more evidence” of a further cool-down.

Jim Tankersley

President Biden stressed the positive long-run inflation trend in a statement released by the White House. “My top economic priority is lowering costs and today’s report shows we continue to make progress on that front,” he said. “Inflation is down two-thirds from its peak and annual core inflation is the lowest since May 2021. Wages are rising faster than prices over the last year and since the pandemic.”

But as he often does, the president said more work remains on bringing prices down. “As I said in my State of the Union, we have more to do to lower costs and give the middle class a fair shot,” he added.

Joe Rennison

The S&P 500 rose 0.4 percent in morning trading in New York. The 10-year government bond yield rose 0.05 percentage points, to 4.14 percent.

S&P 500

Advertisement

Stock prices are nudging higher but so are U.S. government bond yields, which underpin interest rates across debt markets. Investors are encouraged that housing inflation eased in February, even as inflation overall was faster than forecast. That means the prospect of immediate Fed rate cuts dimmed, while the potential for rate cuts at some point this year remains the consensus expectation.

Lydia DePillis

Price hikes this month were dominated by the volatile energy sector — including the jump in airfares, which tend to rise with fuel costs. Food and housing rose more moderately but these prices still haven’t been coming down as quickly as consumers and the Fed would like.

Monthly changes in February

Percent change from January to February in a selection of categories of the Consumer Price Index, adjusted for seasonality

Republicans were quick to target President Biden for the rise in inflation. “Inflation is Up and Biden is to Blame,” the Republican National Committee headlined a news release. A group supporting former President Donald J. Trump in his campaign against Biden declared “The Price Of Eggs Is Up 49 Percent Since Biden Took Office.”

J. Edward Moreno

Several large retailers have reported earnings in recent weeks, many of them looking forward to inflation continuing to moderate because high food and housing prices typically lead consumers to spend less on discretionary items like clothes or electronics.

“Disinflation is the word of the quarter in retail,” Michael J. Fiddelke, Target’s chief financial officer, said in a March 5 earnings call.

Prices continue to rise fastest in the South, at 3.7 percent over the year, and the West, at 3.2 percent. In the Northeast, they have increased 2.4, and 2.8 percent in the Midwest.

The steepest increase among large cities came in the Miami metropolitan area, at 4.9 percent since last February.

The U.S government bond market, which underpins interest rates across business and personal loans, has been somewhat muted. Investors are weighing the higher-than-expected inflation level with some hope over a noticeable decline in housing inflation, which has been one of the hardest price rises for the Fed to slow.

Housing cost increases moderated in February but remain elevated.

The cost of shelter increased at a slower rate in February than it did the month before, but housing remained the largest component of the increase in the core of the Consumer Price Index, which excludes volatile food and energy prices.

Prices rose 0.4 percent over the month, down from 0.6 the month before. The index has risen 5.7 percent higher over the past year, making up two-thirds of the total core increase, according to the Bureau of Labor Statistics.

Breaking the increase into its components, rent came in slightly warmer than it did in January, at 0.5 percent over the month. So-called owners equivalent rent, which approximates the cost of homeownership, declined slightly to 0.4 percent from 0.6.

The shelter index also includes lodging away from home, including hotels. Although it’s a much smaller component, it sank to 0.1 percent in February, from 1.8 percent the month before.

Economists have been expecting a faster decline in housing prices, because asking rents have been plateauing and even sinking in some parts of the country as more multifamily buildings finish construction and start to lease.

But unexpectedly strong demand for single-family rentals, which are weighted more highly in the homeownership measure, may be buoying the index overall .

Madeleine Ngo

Food price gains eased in February.

Food inflation continued to moderate in February, providing some relief to consumers pinched by higher prices at the grocery store.

Overall, food prices were flat over the month, down from January, when prices rose 0.4 percent.

Grocery prices were also flat, a slowdown from 0.4 percent in January. The cost of dining out climbed 0.1 percent over the month, down from 0.5 percent in January.

Compared to a year earlier, food price gains continued to ease. Food costs were up 2.2 percent in the year through February, a decrease from 2.6 percent in January. However, food prices are still increasing at a faster rate than they were before the pandemic.

Prices for fruits and vegetables fell 0.2 percent in February, down from January, when prices rose 0.4 percent. Meats, poultry and fish prices declined 0.3 percent after they fell 0.2 percent the month before. Prices for cereals and bakery products rose 0.5 percent in February.

Egg prices rose again, climbing 5.8 percent in February from the month before. That was up from January, when egg prices rose 3.4 percent. The recent uptick in egg prices is largely a result of avian influenza outbreaks , economists said. Outbreaks of bird flu also contributed to a big surge in egg prices early last year. So far, egg prices have not soared as much as they did then, and they are still down 17 percent over the past year.

The new data reflect a continuing trend of food inflation cooling as transportation and raw material costs have moderated in the past several months. The cost of eating at restaurants has also not eased as much as grocery prices because business owners are facing more pressure from higher labor costs.

David Ortega, a food economist at Michigan State University, said that food inflation was “moving in the right direction” after peaking at 11.4 percent in August 2022. Although food prices are now increasing at a slower rate, he said that consumers were still struggling to deal with the cumulative effect of inflation over the past few years.

“Food prices are roughly 25 percent more expensive than they were four years ago,” Mr. Ortega said. “That’s taking a toll on consumers.”

Food prices were flat over the month, a slowdown from January, when they rose 0.4 percent. Food inflation also slowed on an annual basis, up 2.2 percent in the year through February, a decrease from 2.6 percent in January.

Egg prices rose again, climbing 5.8 percent in February from the month before. That was up from January, when egg prices rose 3.4 percent.

Stocks wobbled following the fresh data. Higher than expected inflation in February seemed to initially weigh down futures on the S&P 500, which allow investors to bet on the market ahead of when trading opens. But the index has since swiftly resumed its ascent, up 0.5 percent for the day.

The Consumer Price Index climbed 3.2 percent on a year over year basis, up slightly from 3.1 percent previously.

This morning’s inflation report could be a bumpy one for financial markets. As the last major economic update before the Fed meets next week to decide whether or not to cut interest rates, investors are betting on markets moving sharply depending on what the numbers show.

Broadly, lower inflation could keep hopes alive of rate cuts on the horizon. More stubborn inflation could further test investors resolve, with rates likely to stay elevated, keeping pressure on the economy for longer.

This morning’s inflation news could be so impactful that investors are braced for more volatility in equity markets than any other day this month, according to analysts at Citi.

All eyes are on housing as a big inflation driver.

The one category that has a profound ability to move the Consumer Price Index up or down is “shelter,” which encompasses housing costs.

Shelter makes up about a third of the “core” C.P.I., which excludes food and energy. It includes both rent and a measurement of homeownership costs called “owners’ equivalent rent,” which calculates what it would cost to rent a similar home.

Lately, economists have been counting on shelter inflation to come down, which would allow the headline number to recede rapidly. Prices for newly rented apartments have been flattening, and even declining in some markets, such as Austin, Texas; Nashville; and Orlando, Fla. Asking rents were up 0.7 percent in February over the previous year, the smallest increase since mid-2020, according to the commercial real estate services firm CoStar.

But moderating market-based rents take a while to feed into official inflation data, which measures both new leases and those that are already outstanding and take a while to reset.

Beyond that, the measure that tracks the rental equivalent of homeownership has been taking longer to slow than some economists had expected. That may partly be because of a methodological quirk: Strong increases in rents for single-family homes could be pushing the owners’ equivalent rent measure slightly higher, because it weighs single-family homes more heavily.

The upshot is that shelter inflation is not cooling as quickly as hoped. In January, it jumped 0.6 percent over the month, pushing up the overall inflation number .

As shelter inflation lingers, Fed officials are thinking hard about how it will influence the path of overall inflation in the future.

One thing adding to inflation? Insurance costs.

It is costing Americans more to protect against disaster, a development that is pushing up official inflation figures.

Various kinds of insurance — including car, medical and property protection — are costing more, at least as official inflation figures measure them. Although it is tough for economic policymakers to do much to snuff out the various drivers behind the trend, the pressure is helping to increase overall prices.

“Insurance of various different kinds — housing insurance, but also automobile insurance, and things like that — that’s been a significant source of inflation over the last few years,” Jerome H. Powell, the Federal Reserve chair, said during congressional testimony last week. “And it’s to do with a million different factors.”

Vehicle insurance is the one adding notably to overall inflation, said Omair Sharif, founder of the research firm Inflation Insights. Part of the increase in car insurance comes from the fact that parts and replacement vehicles have become a lot more expensive over recent years, and that is slowly feeding through to insurance premiums, he said.

Economists at Goldman Sachs expect that car insurance measure to have picked up sharply again in February, “reflecting strength in online insurance price data,” economists wrote in a note previewing the consumer price release on Tuesday.

Insurance could stop adding so much to inflation with time, as the lagged effects of higher car costs in particular become more incorporated into insurance premiums. But it’s unclear how long it could take the full effect to fade.

And it’s not just car insurance that has been moving up. Medical care insurance is also higher, though it is measured in inflation in a wonkier way, essentially by taking a look at an insurance company’s earnings after it has paid out benefits. Mr. Sharif expects medical insurance to remain positive at least until April, when the data is in for an update, and likely after that.

And tenant’s and household insurance has been rising quickly — likely partly as climate-related problems like wildfires and sea level rise make homes in some regions of the country more expensive to insure, increasing the policy premiums that feed into that measure.

“In the longer term, companies are withdrawing from writing insurance in some coastal areas,” Mr. Powell noted, adding that “it’s a significant issue.”

Summers: Inflation Reached 18% In 2022 Using The Government’s Previous Formula

• Share to Facebook
• Share to Twitter
• Share to Linkedin

Former National Economic Council Director Lawrence Summers is pictured before President Barack Obama and Vice President Joe Biden spoke about Middle Class Working Families Task Force, Friday, Jan. 30, 2009, in the East Room of the White House in Washington. (AP Photo/Charles Dharapak)

Numerous commentators—especially those defending President Biden’s economic record—have puzzled over why Americans are sour about the state of the U.S. economy. Unemployment rates have returned to pre-pandemic lows, commentators correctly point out, and the official rate of inflation is declining. So why are Americans ignoring the view of many experts that the economy is doing well?

According to a striking new paper by a group of economists from Harvard and the International Monetary Fund, headlined by former Treasury Secretary Larry Summers, the answer is that Americans have figured out something that the experts have ignored: that rising interest rates are as much a part of inflation as the rising price of ordinary goods. “Concerns over borrowing costs, which have historically tracked the cost of money, are at their highest levels” since the early 1980s, they write. “Alternative measures of inflation that include borrowing costs” account for most of the gap between the experts’ rosy pictures and Americans’ skeptical assessment.

Inflation is not an objective number, but a judgment call

At the heart of the issue is a misconception that bedevils academics, journalists, and ordinary Americans: the idea that the official inflation rate is an objective number, impervious to human biases, much in the way that someone’s height or weight can be objectively measured with a ruler and a scale.

In fact, the formula used to calculate the inflation rate is subjective . It requires economists to make hundreds of judgment calls about how one assesses the overall trajectory of prices. What goods and services should be included in the “basket” of prices in the formula? How should those goods and services be weighted against each other? How do we account for the fact that poor people consume different things than rich people , or that people in different parts of the country may consume different things in different proportions?

And, most relevant to the new research: What is the best way to measure changes in the price of important things like housing? There has always been considerable debate about this .

The most widely used measure of inflation in the U.S. is the Consumer Price Index for All Urban Consumers , or CPI-U, which is put out by the U.S. Bureau of Labor Statistics (BLS). This formula has undergone numerous revisions from its creation in 1919 to the present day.

Consumer prices no longer include the price of money

Most notably, as Summers and his coauthors Marijn Bolhuis, Judd Cramer, and Karl Schulz point out, in 1983 the BLS eliminated interest costs from its calculations of consumer price inflation. The argument at the time, made by BLS economist Robert Gillingham , was that including home mortgage interest rates in the CPI formula was overstating inflation. Instead, Gillingham argued, the BLS should estimate what homeowners could charge if they rented out their homes, and use that to calculate housing inflation.

This change had a huge impact on the calculation of CPI, write Bolhuis et al., because the BLS removed housing prices and financing costs from the official CPI formula, even though everyday Americans still experienced those costs in the real world. “Owners’ equivalent rent”—the new CPI measure—amounts to over a quarter of the Consumer Price Index today.

Bolhuis et al. point out that the elimination of interest costs from CPI isn’t just about housing. “New and used vehicles combine to represent nearly 7 percent of the CPI,” they point out, but “exclude financing costs.” Given that four-fifths of all new cars were purchased using auto loans, this makes no sense.

Furthermore, more people buy consumer goods with credit cards than with cash—and yet the interest costs of credit cards aren’t included in the official BLS formula. “Measurements of the cost of living that exclude financing costs,” Bolhuis et al. argue, “will understate the pressure under which consumers, who rely on credit for many purchases, have found themselves.”

Inclusive of interest costs, inflation reached 18% in November 2022, and remains elevated.

What would inflation look like under the pre-1983 formula?

Bolhuis et al. then went on to see if they could recalculate the official CPI numbers using a pre-1983-like formula that incorporated the cost of mortgage interest, auto loan interest, and credit card interest on the cost of living. They found three things: first, that the pre-1983-like formula led to a dramatically different estimate of inflation in 2022 and 2023, peaking at 18 percent in November 2022.

Second, they found that consumer sentiment—as measured by the widely-used University of Michigan Index of Consumer Sentiment—correlated much more strongly with the pre-1983 CPI formula than it did with the modern one that excludes interest costs.

Third, they found these differences to be also true in Europe: higher interest rates were correlated with lower consumer sentiment, and vice versa. This was an important finding, as some have suggested that the gap between American consumer sentiment and the official government statistics is a result of Americans’ mistrust of institutions and mainstream sources of information. “We find little evidence that the United States, despite its rising partisanship, social distrust, and large reported levels of overall ‘referred pain’ differ meaningfully” in their economic perceptions from those in peer nations.

“Consumers are including the cost of money in their perspective on their economic well-being, while economists are not,” the authors conclude. Since home and auto purchases “are integral to American consumers’ sense of their economic well being but their price is not included in official inflation measures, it is no wonder that sentiment lags traditional measures of economic performance.”

The gap between CPI and the pre-1983 formula could widen over time

There are other obvious problems with relying on the declining rate of official CPI inflation to gauge what consumers should be feeling. Inflation is cumulative; a decline in the rate of inflation does not reverse the price increases from previous years; it simply means that prices are now rising at a slower rate.

Most importantly, the exclusion of interest costs from the CPI and the Federal Reserve’s preferred measure of Personal Consumption Expenditures could become a growing problem over time, due to the ever-expanding federal debt.

As the debt increases, the federal government has to borrow more money from U.S. and foreign investors. But as would-be lenders to the U.S. see America as increasingly insolvent, investors will demand higher interest rates to lend us that money. Higher rates of government borrowing lead to higher rates for home mortgages, credit cards, student loans, car loans, and every other form of borrowing. And, as we’ve seen, these higher interest rates lead to higher price inflation, whether or not the Bureau of Labor Statistics recognizes it as such.

In recent years, the Federal Reserve has suppressed these higher interest rates by printing new dollars out of thin air to lend to the U.S. government. But printing new money can also cause inflation, by decreasing the purchasing power of each preexisting dollar in circulation.

We need a healthier debate on how to measure consumer price inflation

Those who believe in the primacy of experts have long attacked those who question the accuracy of the BLS’ inflation measures. Balaji Srinivasan, the venture capitalist and entrepreneur, was criticized by mainstream commentators for investing in Truflation , an attempt at independently developing a measure of inflation using real-time price data from a variety of sources.

But whether one likes or dislikes Truflation’s methodology, we should be encouraging independent thinking on how best to measure prices in the economy. As the IMF-Harvard analysis shows, the Bureau of Labor Statistics is capable of making misjudgments. My colleagues Jackson Mejia and Jon Hartley at the Foundation for Research on Equal Opportunity have shown that even relatively low rates of inflation disproportionately harm the poor, because the poor lack the financial wherewithal to absorb higher consumer prices.

It’s important—and healthy—for us to look at different measures of consumer prices. Everyone has a stake in the outcome, especially those who live paycheck to paycheck.

• Editorial Standards
• Reprints & Permissions