US inflation seems to be cooling: What is behind the welcome slowdown?

December 2022’s winter weather seems to have also cooled inflation in the United States as the consumer price index reached 7.4 percent last month.

According to the Bureau of Labor Statistics, for which November’s data is the latest available, inflation is down from 8.1 percent in October.

The consumer price index is the U.S.’s popular measure of inflation. While the Federal Reserve raised interest rates for the last few months in 2022 to lessen inflation’s fire, the tradeoff was slow consumer demand and threat of recession.

Inflation has been at the top of the news throughout 2022, along with high gas prices, high food prices, supply chain challenges and labor shortages. And the possibility of a recession in 2023 is not off the table yet.

WalletHub, a personal finance website, released its latest report on Cities Where Inflation is Rising the Most last month. The website compared 22 major Metropolitan Statistical Areas across two key metrics involving the Consumer Price Index.

Inflation rose the most in Phoenix, Miami, Detroit, Seattle and Anchorage, but rose the least in Houston, Washington, D.C., Denver, St. Louis and New York City.

“There are several factors causing inflation. First, we had an increase in demand for goods during the pandemic (disposable income actually increased fairly significantly during the pandemic due to the government’s response),” Dr. Liam C. Malloy, chair and associate professor of the Department of Economics at the University of Rhode Island, said in a press release. “Unfortunately, the economy was not able to meet this demand because of supply constraints related to the pandemic. Whenever demand increases and supply decreases, we will see an increase in prices. This initial inflation has been exacerbated by the war in Ukraine which has pushed up both energy and food prices. There is also the possibility that firms are more able to increase prices because of a general lack of competition as industries have been consolidating over the last few decades.”

According to Amitrajeet A. Batabyal, Distinguished Professor and Interim Head of the Department of Sustainability at Rochester Institute of Technology, the main factor with inflation is demand exceeding supply.

“This rising demand was caused, in part, by Uncle Sam providing massive stimulus funds to aid Americans who would otherwise be in considerable financial distress. The availability of more money has increased consumption or demand and supply has not been able to keep up with rising demand. There are other factors as well such as international supply chain disruptions,” Batabyal said.

Batabyal said a balancing act is involved with raising the interest rate to control inflation.

“Raising rates a little can slow demand and thereby reduce inflation. On the hand, raising rates too much risks moving the economy in the direction of a recession,” Batabyal said in the press release.

Malloy said the solution right now seems to be increasing interest rates, but higher interest rates cools off the housing market and can encourage decreased consumer spending.

“The problem with raising interest rates is that it is a blunt instrument. It does not specifically target the areas in which prices are increasing most quickly and if the Fed raises interest rates too high, we could end up in a recession. This is further complicated by the fact that when the Fed raises interest raises this strengthens the dollar as investors want to buy more Treasury bills and Treasury bonds. The weaker foreign currencies can make inflation in those countries worse as they pay more for imports. This may turn into a fairly serious problem as some countries face fuel and food shortages,” Malloy said in the press release.

What about the future of the American economy?

“The current inflation rate reflects many factors that were unique to the response to the COVID-19 pandemic,” Dr. Michael Connolly, assistant professor at Colgate University, said in the press release. “The necessary response to high inflation is to increase interest rates. The effects of higher interest rates have cooled housing almost immediately, but we should expect that consumer and business spending will soften in coming quarters. Whether the U.S. economy experiences a relatively deep recession in 2023 depends crucially on how the labor market holds up in the face of rising interest rates. In addition, if inflation begins to come down faster than expected, we would expect the Fed to slow interest-rate increases. Both of those factors are key for the outlook in 2023.”

Dr. Gabriel Mathy is associate professor at American University, and he said the current inflation rate is high and the Fed will keep increasing the interest rate.

“This will slow down the economy, will mean the stock market performance will be weak or negative, and mortgage and auto rates will be high, and likely are going even higher,” Mathy said.