Why is inflation so high? An economist explains why everyday essentials cost more

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As prices continue to increase across a broad range of spending categories, many Americans are finding that their paychecks aren't going as far as they used to. That's probably because in June, the year-over-year inflation rate, as measured by the Consumer Price Index, was a whopping 9.1%, the highest it's been in over four decades.

So, what's given rise to higher prices at the gas pump and or at your local grocery store? Well, there are a variety of different causes — from international conflict to changes in what consumers purchase. 

Below, Select spoke with Michael Gapen, head of U.S. economics research at Bank of America, about some of the reasons behind the record-high inflation rates.

First off, let's establish some basics about inflation, which is the increase in the price of goods and services over a period of time. In order to measure inflation, economists use a price index to look at price changes across a number of different goods and services.

Though there are many different indices, the Consumer Price Index for All Urban Consumers, or CPI-U, is one of the most popular, measuring price changes within a theoretical basket of goods and services for urban consumers, including food, apparel and automobiles, among other categories.

The Federal Reserve uses a different price index to measure inflation — the Personal Consumption Expenditures, or PCE Index — which similarly measures price changes among goods and services.

Lastly, the core inflation rate refers to an index that excludes volatile spending categories such as food and energy, and can be a useful index for economists since food and energy prices can fluctuate significantly. 

The current high inflation rate can be attributed to many different factors, many of which are a result of the Covid-19 pandemic.

Gapen pins rising prices on three general causes — increases in household demand and supply-chain shortages due to the pandemic, the war in Ukraine and the presence of a strong labor market.

Generally, the story goes something like this: At the start of the pandemic, consumers began spending less because of lockdowns, and in turn, started saving more. Then, when Covid-19 restrictions eased, people started spending more again. Companies, however, couldn't keep up with this increased consumer demand — many of them had reduced production because of the pandemic and experienced shipping delays as well as shortages in labor and key inputs. 

The result of all these things? Higher prices for most goods and services.

While price increases were seen across multiple categories in June, some of the largest price hikes occurred in gasoline, shelter, and food — the year-over-year increase in food prices was 10.4%, while for shelter it was 5.6% and for energy prices, 41.6%.

Shelter, food, and energy are also the major categories that make up the Consumer Price Index, accounting for nearly 54% of the entire index.

Though energy commodities such as gasoline and services such as electricity are not weighted heavily in the Consumer Price Index, energy prices have also risen significantly, with gas prices increasing 60% year-over-year. 

While gas prices have declined in the past month, they still remain high — the American Automobile Association reports that the national average for a gallon of gasoline is $4.28, as of July 28.

Just as there are many causes of broad-based inflation, there are many factors that have given way to higher energy prices as well. Perhaps most notably is Russia's invasion of Ukraine and Western countries' resulting sanctions which put severe limits on the import of Russian oil. Both events played a significant role in rising energy prices and supply-chain issues, as has fluctuating consumer demand for gasoline.

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Gapen also notes that the shift away from spending on goods and toward services has affected inflation. While consumers purchased more goods during the pandemic since they were stuck at home, many are now spending more on services, such as travel and concerts, than they had been.

In fact, services prices comprise a large percentage of the Consumer Price Index — nearly 57% — including big expenses such as shelter as well as smaller ones such as car rentals. 

"A lot of service prices fell as consumers weren't traveling on airlines and going to hotels. In the past 12 months, many of those prices have rebounded," says Gapen. "The unemployment rate is 3.6%. There's a high demand for labor and strong wage gains. Labor is the number one input for services production. In general, it's about half of any cost of production on the service job."

In other words, a tight labor market has led to increased labor costs, which have in turn increased the cost of services that consumers pay for. 

There are many different factors affecting inflation, ranging from geopolitical conflict and changed consumer behaviors due to the ongoing Covid-19 pandemic. Some of the categories with the largest price increases — shelter, energy and food — also make up most of the Consumer Price Index, which all points to consumers having to spend more than usual on many of their everyday expenses.

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