Understanding the economic situation in early 2023 in the US, its causes and the directions it is likely to take, is very important to any company seeking stability and growth, and particularly with regard to staffing and recruitment. This article is written to give an entry level understanding of the situation.

Some fundamentals

Inflation is a rise in prices across an economy. Prices are expected to rise. Central banks try to control this increase. The U.S. Federal Reserve aims for a 2% increase in prices annually. That is expected inflation: the rise in the cost of living. Moderate inflation is a sign of a healthy, growing economy and consumers accept it.

Beginning in May 2021, the rate of inflation in the US soared up reaching 9.1% in June 2022, YoY. The average inflation rate in the US over the last 10 years is 1.88%. Inflation in the US in 2022 is the worst it has been in decades. The average inflation in the US for 2022 was 8%. It hasn’t been that high since 1981 when it was 10.3%. The inflation in January 2023 was down to 6.45.

Some basic causes of the current excessive inflation

There are many factors that have contributed to the current inflation excesses. Some of the larger ones can be traced back to the Covid-19 pandemic and its after-effects. At the start of the pandemic, consumers started spending less and saving more. As the pandemic eased, and with the help of the government pumping money into the economy, they began spending more again. Many companies struggled to keep up with this increased demand since many of them had cut back due to the lower demand. Supply could not keep up with demand across many sectors. Prices rose accordingly. The US has seen year over year price increases of 10.4% for food, 5.6% for shelter and 41.6% for energy in 2022.

Russia’s invasion of Ukraine and the sanctions imposed by Western countries has added to the large increases in energy costs in particular.

Results of excessive inflation

What happens when inflation gets too high? The money in your wallet or bank account buys you considerably less than it did a while before. But you’re earning the same. So, wage earners ask for higher wages so that they can afford to live the way they’ve been living. Higher wages increase the cost of goods and this can spiral upwards. It can lead to companies laying off employees in large numbers so that they can keep their costs down. It’s a vicious circle.

Inflation and interest rates – a fine balance

A country’s central bank uses interest rates to control inflation. When inflation is high, they take steps to raise short-term interest rates. The higher interest rate discourages companies and consumers from borrowing and therefore spending. This lowers the demand for goods and investment which in turn reduces inflation. Since inflation follows the concept of supply and demand, lowering this demand reduces the pressure for prices to rise. Inflation slows. In the US the interest rate is set by the Federal Reserve.

The amount by which the Fed is hiking the interest rates has slowed as inflation has also dropped. In February the Fed raised the target range for interest by .25% which is half of the previous hike which was .5%. However, the cost of borrowing is still the highest it has been since 2007. Raising the interest rates too high can cause a recession. It’s a fine balance. The aim is to reduce inflation back to 2%.

The chart shows clearly how the increased interest rate has resulted in lowered inflation.

Summary

This should make it clear what is going on with inflation and interest rates.

Time alone will tell if the Fed got it right.