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Inflation Has Reached a 31-Year High – Is It Really That Bad?

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In October, consumer prices in the United States continued to soar, reaching a 31-year high. The Consumer Price Index for All Urban Consumers (CPI-U) increased by 6.2% year over year, while the core index, which excludes more volatile food and energy costs, increased by 4.6 percent from October 2020 levels. These were the highest values since November 1990 and August 1991, respectively, reawakening long-dormant inflation anxieties.

When inflation surged this year in the spring/early summer, it was mostly owing to the so-called base effect, which was triggered by the pandemic’s cooling influence on consumer prices a year earlier. At the outbreak of the pandemic, prices plummeted due to a sharp decline in consumer spending and gasoline demand, before gradually returning to pre-pandemic levels over the summer and fall. Due to the early decline in consumer prices, year-over-year comparisons were always going to be inflated this year, as last year’s prices were abnormally low.

Therefore, are inflation fears valid, or is it too soon to sound the alarm? The Federal Open Market Committee stated in April that it would target “inflation substantially over 2% for some time” before raising interest rates to reach a long-term average of 2% inflation. And, while the committee’s definitions of “moderately above” and “for some time” are imprecise, its long-term goal of 2% inflation is crystal clear.

To account for the pandemic’s short-term consequences, we estimated the average annual inflation rate over a rolling three-year period, resulting in a curve that wavered around 2% for a long period before taking off this summer. The three-year average inflation rate reached 3% in October, indicating that the recent increase in consumer prices is more than a statistical fluke and should be treated seriously.

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