Prices are Rising While Wages are Stagnating: Inflation Explained

Inflation is at the highest level it’s been in four decades. What’s weird for anyone but an economist is that prices started rising when the economy reopened in November 2020. You’d think opening our doors for business following the Covid shutdown would have put us back on our feet. Instead the prices of food, rent and basic necessities have continued to skyrocket. And though prices eventually fell at the gas pump, Rhode Islanders can expect to see their electric bills increase on average by $50.76 this month because the price of natural gas is still surging (38 percent of electricity in the United States is generated by natural gas). And if you got a raise, it counts for nothing because inflation is rising faster than the cost of living.

In this Q&A, RIC Assistant Professor of Economics Ignacio Ramirez Cisneros gives us the scoop on inflation.

Professor, could you start by defining inflation?

Inflation is a sustained, general increase in prices over a period of months.

What triggered this inflation? How did we get here?

One of the reasons is the supply chain shock and labor shortages. Due to the public health response to the Covid pandemic, production stopped or stalled in many important sectors and employees were laid off or were getting sick from Covid, creating a backlog in the production of strategic commodities, goods and services that you need in a modern industrialized economy. Modern economies function with very lean inventories to begin with.

Secondly, there was an increase in discretionary income by those unaffected by the layoffs. People who didn’t lose their job during the pandemic, whose incomes weren’t affected by the shutdowns, suddenly had extra discretionary income to spend, so they started bidding up prices in an attempt to outbid each other for products that are in short supply, such as used cars, new cars and housing. That leads to inflation.

A third reason is Biden telegraphed to the market that he was going to transition the United States away from traditional sources of energy and move toward renewable energy. In economics, information moves prices even before any action is taken. If you’re a good investor, you use that information to play your cards. If you’re a lender and you hear that the President is going to transition to renewable energy, you’re going to think twice about lending to an oil driller who’s in a sector that’s being phased out. The price of oil and natural gas reacted to Biden’s announcement and began to rise.

The war in Ukraine is the latest contributor to record energy costs. [Russia is the second-largest exporter of crude oil and the world's largest natural gas exporter. When the U.S., the EU and the UK put restrictions on imports of Russian oil and gas after Russia invaded Ukraine, it drove up the cost of these commodities.]

In summary, it was mostly supply-side factors that pushed prices up.

The Feds have raised interest rates five times this year in order to tame inflation. How do interest rates impact inflation?

The central bank’s traditional response to rising inflation has always been to raise interest rates. It’s designed to increase unemployment and decrease spending in order to get prices to stabilize. [If interest rates are high it makes borrowing more expensive. When people stop borrowing, they have less money to spend. If they have less money to spend, they buy less, and prices stop rising.] It is a very blunt policy instrument.

Are there certain jobs that will be impacted more than others?

Jobs tied to discretionary spending, such as the hospitality industry, are going to be hardest hit as people cut back on spending in order to afford basic necessities.

What can we do to protect ourselves from the fallout?

If you’re a RIC student, make sure you graduate; increase your skill set to make yourself more attractive in the labor force, be wise with your spending and pay down your debt, if you can.

Now that we’ve heard the bad news, what’s the good news?

The good news is, after Covid, we realized that our supply chains are too widespread. There’s a trend now to bring strategic supply chain manufacturing back to the United States. That means there’s going to be more jobs available in those sectors. For instance, legislation was passed in August to bring back the production of semiconductors and chip technologies to the United States [the CHIPS and Science Act of 2022]. Currently, Taiwan makes a lot of these chips. Investment in U.S. production will lessen dependence on a foreign supply chain that has become a threat to national security.

The other good news is that despite inflationary pressure, despite commodities prices going up, the dollar is stronger than almost any other currency in the world right now. The dollar is still the safe-haven currency of the world and the U.S. is still the safe-haven market.