Why Has Inflation Remained Stubbornly High?
On Wednesday, the Department of Labor confirmed what many on Wall Street already surmised – that high inflation still poses a significant risk. According to the latest Consumer Price Index, in December, consumer prices rose another 0.4%, matching the highest monthly increase in 16 months. The national rate of inflation also jumped from 2.7% to 2.9%, a five-month high. Core inflation, which strips out the more volatile and seasonal food and energy prices, was reported even higher at 3.2%.
After reaching a 40-year high of 9% in June 2022, inflation finally began to moderate. By June 2023, inflation had declined to 3.1%. Make no mistake, consumer prices were still rising, just at a slower pace. With an inflation rate at 3.1%, that meant that consumer prices, on average, had still increased by 3.1% over the past 12 months.
But that downward path of inflation hit a brick wall. Inflation has still yet to fall to the Federal Reserve’s target rate of just 2%. The last time inflation was reported at, or below, 2% was back in February 2021 (1.7%). Moreover, over the past three months, the direction of inflation has started to trend higher.
But why has inflation remained so stubbornly high for so long? If you remember, throughout 2021, much of the explanation for rising prices was about disruptions to supply chains and a labor shortage – both end results of the global pandemic. But supply chain issues and the labor shortage have long since ended. Yet here we are, nearly four years later, with excessively high inflation that is drifting farther and farther away from our 2% goal.
Instead, the main driver of this inflationary cycle has been the massive amount of government stimulus money that has flooded the economy. In response to the global pandemic, Congress passed more than $6 trillion in related stimulus spending. With the stroke of a pen, this money was simply “created” and doled out to consumers, businesses and local governments to spend at will.
The classic definition of inflation is the percentage increase in consumer prices over the past 12 months. But inflation can also be defined as “too much money chasing too few goods.” From February 2020 to April 2022, the nation’s M2 money supply surged by more than 40% to a record-high $21.7 trillion.
The M2 is a classification used by the Federal Reserve to measure the total value of U.S. currency within the economy at any given point in time. The M2 is defined as the total amount of currency in circulation plus any money held in checking and savings accounts, CD’s and money-market accounts. It is a broader measure of our money supply and is frequently used as an indicator of future inflation.
Increasing the M2 money supply by 40% adds a lot of money to our economy. And what do consumers, businesses and local governments do with that extra $6 trillion? They spend it. And all that added spending creates tremendous upward pressure on prices.
From its record-high level of $21.7 trillion in April 2022, the M2 money supply gradually fell by $1.1 trillion, or 5%, by October 2023. Since then, however, the M2 has been steadily rising over the past 16 months. Currently, the M2 stands at $21.5 trillion, just $200 billion shy of its April 2022 all-time high. This means there’s still 39% more money floating around the U.S. economy than its pre-pandemic level in February 2020. Thus, it’s of little surprise that inflation has remained stubbornly high and has actually started to rise again over the past few months.
Understandably, the rationale behind the initial surge in our nation’s money supply was to combat the economic toll caused by the pandemic. But that was nearly four years ago. Moreover, it appears there’s been little appetite to address this issue. As I’ve said before, flooding the economy with $6 trillion in cash with the stroke of a pen has consequences. And one of those consequences is high inflation.
Mark M. Grywacheski, Investment Advisor
Quad Cities Investment Group is a Registered Investment Adviser.
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