Consumer price index inflation levels have reached new worrying levels of a 40 year high. US consumer prices rose by 8.5% in March (a 0.6% increase from the previous month). To contrast, only a year ago CPI inflation was at 2.6%.
The consumer price index is measured by tracking 650 commonly brought goods, known as the basket of goods. These goods are frequently purchased by the ‘average’ household. Items include electric cars and hand hygiene gel, and are weighted by importance. For example, if a household spent 5% of their income on apples and 32% on jeans, then the weighting would be 5 and 32 respectively.
The recent inflation rise is partly attributed to the US sanctions placed on Russian commodity exports. Following the invasion into Ukraine, President Joe Biden banned all imports of gas and oil from Russia.
With Russia being the world’s second largest oil exporter, the ban has had huge implications on the US economy. US energy prices have risen to 32% according to the country’s Labour department.
Rising food prices are also partly responsible for the rising price level. Up by 8.8% in price, food price inflation has been exacerbated by Russia’s invasion of Ukraine as both nations are big exporters of widely-used goods like wheat and sunflower oil.
Kathy Bostjancic, chief US economist at Oxford Economics explains the situation; “The Russia-Ukraine war has added further fuel to the blazing rate of inflation via higher energy, food and commodity prices that are turbo charged by a worsening supply chain problems.”
To deal with inflation, the Federal Reserve has implemented contractionary monetary policy. This includes rising interest rates so that the cost of borrowing rises. With less people borrowing, spending and consumption levels fall, causing aggregate demand to fall and price level (inflation) to decrease.
However, due to the rising inflation benign cost push (with some demand-pull factors due to high employment in the US), raising interest rates does relatively little to cool down inflation. At best, demand pull deflation (falling inflation) would offset rising cost push inflation.
It is important to also note that increasing interest rates will make the costs of debt higher (as the interest charged on the original amount is growing rapidly). This decreases financial stability and the risk of debt deflation looms more imminently.
This put all together raises many concerns on whether the US economy is on the precipice of a recession. Furthermore, the interconnectedness of economies makes this threat of serious concern to nations all over the world who are key trading partners with the US, as any disaster occurring in the US will surely infect them too.
Written by Charlotte Hurst