Inflation - ELI5, How Do We Get These CPI Numbers

Hey guys,

I like to think I'm a smart guy, but I can't grasp the concept of inflation. So from what I've seen every month they release CPI data on how food, energy, other mostly everyday costs have gone up. Recently it's been high 7-8%. My questions/thought process below.
 

Questions:

  1. Why are prices going up so much? People are saying it's because there's less of a supply chain (lower supply of say food), coming out of covid there's higher demand (how, it's the same people wanting the same goods). I can somewhat see it but still don't fully get it.
  1. Why are prices going up by so much? Seems to be phantom demand for food energy. I assume the cost of say food is looked at across grocery stores in real time price of milk last month vs now. Also it seems these costs have been fluctuating around 7.7-8.3% monthly but I'm assuming these are annual costs? What does this % actually mean?
  1. So the solution by the government is what? Throw money at it, give subsidizes to offset these costs. Are the debt markets playing a factor bc higher interests/borrowing costs = higher costs across the board. 
     

  2. How will higher rates slow the economy/inflation? So less debt available = less money to spend I guess? So that brings down prices because less people are buying is that it? We're still seeing strong job growth, people still have a need for necessities - How will all of this throw us into a recession if fed doesn't get these rate hikes right?

Comments (5)

2mo
SwansonOrSamsonsite, what's your opinion? Comment below:

No expert here, but you asked to ELI5: prices went up due to demand increasing significantly beyond the earlier parts of the pandemic - unusual savings for large sectors of the economy (no/less commutes and social activity... how much do we spend at bars and restaurants, travel, etc.?), historically low interest rates to spur the economy and robust job market (salaries significantly increased for many once the economy came roaring back). Pent up demand. All of this lit a fire under Consumption's ass in short order once things opened back up. It's not the same people and same goods as you put it, but likely more people buying more (or perhaps nearly same people buying more); on a macro scale, when times are good, people spend more.

On the supply side, supply chain issues limited supply for many goods throughout the pandemic (there's plenty of in-depth research on this, it's rather interesting) that may not have stabilized fully before eventually the war in Ukraine broke out which of course is impacting supply of many things on a global scale. 

While incomes for many have increased significantly, inflation has hit many people hard and not just low wage workers. You're on a real estate forum... needless to speak about rent increases for MF renters in most markets. That pay raise you got is great, but when you're paying 30% more in rent than you were two years ago on top of for pretty much everything like food and gas, that evaporates a lot of savings. Imagine the impact on lower wage workers... they simply can't keep up in this economy. So yeah, recession...

  • Analyst 2 in RE - Comm
2mo

Got it and recession, a reduction in the amount of economic activity. Makes sense people can't afford to spend more.

So now with rates, that's making borrowing (if any of happening from lenders) or variable rate loans more expensive. That may translate to the need to increase prices to cover that rise in cost from a business perspective. 
 

So on inflation that's the costs of goods increasing generally around 2-3% but always floating and not static. Now it's at 8.x% this last month, how is raising rates (thus making things more expensive as described above) make inflation go down? Is that just rates go up, people spend less, prices come down?

2mo
SwansonOrSamsonsite, what's your opinion? Comment below:

The rising rates is the Fed's response to combat the runaway inflation. Higher rates = less spending because it's now more expensive to borrow money, and conversely incentivizes saving (more saving = less spending/consumption). How businesses respond will vary across industries, but generally speaking demand is going to drop all else equal and therefore prices can't keep rising... they will level off or potential return to a more stable lower level. 

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2mo
e46fanatic99, what's your opinion? Comment below:

Here's my long winded perspective of how I think inflation in the US has evolved from a steady 2% rate pre-covid to close to 9% y/y today and what likely lies ahead:

I think the inflation situation we're in can be broken into phases where different factors were predominantly driving inflation and compounded on top of each other, resulting in the recent record high inflation prints this century. In the initial months of the pandemic we experienced a bit of deflation as activity was stalled and everyone hunkered down at home. In this phase, our population as a whole saved up a ton of money as our personal savings rate jumped from like 7% pre-covid to a peak of 30% in spring 2020 and stayed elevated in the teens until late last year. The ability to work remotely, unemployment benefits, and stimulus checks combined with limited ways to spend money lead to this "excess savings".

2% annual inflation was the steady norm before the pandemic and once covid hit, inflation stayed below 2% until vaccines were largely rolled out and things reopened in Q1 of 2021. From then on, through summer 2021, inflation steadily accelerated to the 5-6% range as people started to feel safe going about normal life again and enthusiastically spent some of their excess savings (+gains made in markets) on living it up and making up for lost time & experiences over the pandemic which lead to the personal savings rate to drop to around 9% by the end of summer '21. 

Inflation during this post-vaccine period was largely deemed to be "transitory" as policymakers attributed the inflation spike to pent up demand and savings being unleashed in the economy. But to the surprise of many, inflation continued to accelerate from the 5% range in Sept '21 to almost 8% in Feb '22  right before the Ukraine war. I think the continuation and snowballing of supply chain issues/bottlenecks going into 2022 were the primary drivers here and were exacerbated by fall/winter 2021 being the 1st "safe" holiday season since the pandemic started and ppl spending more to make up for lost celebrations and gifting...Our global supply chains had become so lean and efficiently coordinated over the past couple decades that they couldn't handle the unprecedented spike in goods demand...leading to long queues at shipping ports and higher shipping costs being passed onto consumers. 

Then the war in Ukraine started this year and provided another tailwind for inflation thru supply-side factors. Oil & gas prices accelerated before peak summer travel months as a result of economic sanctions & bans on Russian oil; this reduced global supply which lead to higher prices and since oil/gas is an essential input into almost everything we interact with or purchase, the prices of almost everything were negatively impacted. On top of this, Russia is one of the largest exporters of fertilizers which are essential for growing crops/produce, so the sanctions on Russia also contributed to fertilizer costs rising over 30% since the beginning of the year- leading to higher food prices worldwide.

Now in this most recent phase since lets say spring of this year, the personal savings rate dwindled down to 5% as savings were depleted, stimmies were no longer handed out, and as inflation continued to eat away disposable income, leaving little left for savings. And by this time, the Fed started to raise rates as it became more and more evident than inflation was running away. Given the dire state of the "average" consumer with depleted savings and less purchasing power as the inflation rate has exceeded wage growth, people over this summer started to re-rack up credit card balances (that were smartly paid down over lockdowns) to record aggregate levels in order to cover expenses. I also think a factor in consumers piling on CC debt is that imo this summer was the 1st true post covid/safe summer where ppl lived without taking caution which has lead to a "yolo" mentality of fuck it, lets just live it up, throw it on the card and make up for the past 2 years.

----

With all that said and with inflation at persistently elevated levels, the Fed has no choice but to "manufacture" a recession via higher rates which will lead to lower lending, spending, more saving, and a reset/correction in financial & housing markets. Basically, the Fed is trying to implement the "reverse wealth effect" which will slow the economy and thus hopefully bring the inflation rate back down to the 2-3% range. By making people "less wealthy" primarily thru devaluing financial & housing markets via higher rates, the end goal of this strategy is that ppl will become fearful of the near term trajectory of the economy and possibly their job so to protect against the loss or reduction in income, people will spend less and save to build up a security blanket.

.....End rant, kudos to whoever was able to stick thru the end of my ramblings haha

2mo
PEarbitrage, what's your opinion? Comment below:

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