MainStreet Macro: Reaction to Inflation

Have you ever returned to a familiar place after a long absence only to find that it’s changed a lot since your last visit? The same can be said for the economy. 

Jobs are set to return to pre-pandemic levels and the economy is closing in on its former growth trajectory. But as the U.S. economy speeds back to its 2019 stomping grounds, it’s not quite like it was before.

What’s changed? It’s more expensive!

Inflation rose to 8.5 percent in March, reaching a fresh 40-year high. Not only that, a measure of what wholesalers pay for goods, before they get to store shelves, rose by 11.2 percent.  That’s the biggest jump on record, and it means there could be more pain in store for consumers.

The breakneck pace of inflation didn’t rankle markets – stock prices were flat after last week’s reports, with analysts positing that the March data could be the peak for price increases.

But Main Street is likely to react differently. Here are three ways Main Street is reacting to high inflation.

Reaction 1: Priced out!

We get two important reads on the housing market this week — housing starts and existing home sales.  Both likely will underscore the housing market’s worsening curse of too much demand and too little supply. Home prices are up 33 percent in the past two years, and homeownership is getting further out of reach for more people.

Mortgage rates are also going up, rising at the fastest three-month pace in nearly 30 years. Rates on a 30-year, fixed-interest home loan hit 5 percent last week for the first time in a decade. That’s up from 3.2 percent at the beginning of the year. 

What happens in the housing market doesn’t stay in the housing market. High purchase prices affect rental prices by adding to rental demand and limiting rental inventory.

Rental vacancies dropped to 5.6 percent at the end of last year, the lowest rate in nearly four decades, which was the last time inflation was this high.

Reaction 2: What happened to my raise?!

While nominal wages accelerated over the past year, real wages — what people earn after taking inflation into account — slid backwards.

The 10 years of economic expansion that preceded the pandemic — the longest period in U.S. history without a recession — was marred by tortoise-like wage growth. 

Nominal wages inched along from the time of the Great Recession in 2009 to the start of the pandemic, growing less than 3 percent, below the 50-year average of 4 percent. Wages barely kept pace with the slow pace of inflation during that time.

Now wage growth is more hare than tortoise, reaching roughly 6 percent in March. But with inflation speeding ahead, real wages are negative even though take-home pay looks higher.

Just like in the classic children’s fable, the tortoise wins.

Reaction 3: But inflation has peaked, right?

There are signs that inflation reached a peak in March after steadily climbing for a year.

Supply-chain bottlenecks are easing despite notable challenges, including worker shortages, pandemic-related disruptions, and the geopolitical crisis in Ukraine. Pandemic disruptions are fewer and more isolated.

Used car prices, which shot up during the pandemic, have come back to earth. More people are back in the labor market, which has reduced the economic impact of absenteeism. Even energy prices here in the U.S. are likely to stabilize.

That being said, prices aren’t returning to 2019 levels. Even as the pace of price growth slows, things will still be more expensive.    

And because house and apartment leases are annual, the impact of housing inflation won’t fully show up in the data for many months.

My Take

Main Street’s reactions –and behavior – matter a lot. Inflation can be a self-fulfilling prophecy.  When companies and consumers expect higher inflation, they can behave in ways that bring it about, for example, by raising their own prices. 

So far, it doesn’t look like Main Street has accepted accelerating inflation as its new normal. Long-term indicators suggest that consumers expect inflation to fall below 4 percent over the next three years.  Yet prices have shot up for the better part of the year. Even though they’re likely to grow more slowly in the months ahead,