Why is it difficult for inflation in the United States to decline?

The US Department of Labor released the latest inflation data on the 13th. Its subsidiary, the Bureau of Labor Statistics, announced that the US Consumer Price Index has risen for the second consecutive month, with a year-on-year increase of 3.7% in August, an acceleration from July's 3.2% growth rate. Although the core CPI, excluding volatile items such as food and energy, slowed down to 4.3%, the month on month increase was higher than expected, at 0.3%.

Previously, another inflation indicator that the Federal Reserve was more concerned about - the Personal Consumer Expenditure Price Index - was also released by the latest data on the last day of August by the Bureau of Economic Analysis, which is under the jurisdiction of the US Department of Commerce. According to the bureau's statistics, the PCE index in July increased at an annual rate of 3.3%, higher than the previous month's 3%; Excluding volatile commodities such as food and energy, the core PCE price index increased by 4.2% year-on-year, which is also higher than the previous 4.1%.

The PCE index measures the changes in people's spending on purchasing a combination of goods and services over a period of time, while the CPI assumes that the share of spending on major goods and services is fixed. In reality, price changes may lead consumers to shift from purchasing one commodity to another, and the PCE index can reflect this substitution phenomenon, making it the preferred indicator for the Federal Reserve to evaluate inflation.

In order to curb significant price increases, the Federal Reserve has raised interest rates 11 times in the past year and a half, raising the benchmark interest rate to its highest level in 22 years. Although the inflation rate has dropped significantly by about half from last year's peak, the latest released CPI and PCE data both show signs of a rebound in US inflation, especially with the core inflation rate remaining high, about twice the Federal Reserve's inflation target, which is even more headache inducing. Economists are increasingly concerned that US inflation is more sticky than initially anticipated.

After around 1990, there were some changes in inflation behavior in the United States compared to before, and the response of inflation to short-term changes in unemployment rates became less sensitive than before. Due to long-term changes in economic structure, consumer behavior, and labor market, inflation tends to remain stable in the absence of significant supply shocks.

For example, that period was the most rapid period of globalization, where imported goods were of good quality and affordable, helping to lower the prices of American goods. The more flexible labor supply also leads to smaller wage changes caused by changes in demand compared to the past.

But the inflation surge that began in 2021 did not evolve according to the past script, but surprisingly persisted. Why is this?

With the recovery of the supply chain after the epidemic, it is difficult to completely find the cause of inflation in the United States from the supply side. Alexander Chiamalis, Senior Lecturer in Economics at the University of Sheffield Hallam in the UK, believes that there are deeper reasons behind this round of inflation, and under the impetus of some larger forces, the period of high inflation in the United States will be more prolonged.

Firstly, there is a reversal of the trend towards globalization. Ziamalis believes that one of the long-term drivers of inflation is the economic cold war. From the Trump administration raising tariffs to a major trade war, to the Biden administration's so-called "de risk" approach, the United States seeks a "friend shore", "near shore", and "onshore" supply chain and manufacturing, resulting in higher prices of goods in the domestic market and higher inflation.

The second driving force behind long-term high inflation is climate change. The increase in extreme weather events caused by climate change will inevitably disrupt industrial and agricultural production, and the cost of enterprise management and overcoming these natural disasters may be high. The increased costs and government measures such as carbon taxes have been passed on to consumers.

Persistent high prices will spiral up with wages, creating a vicious cycle. High inflation will push up wages, thereby stimulating demand and expenditure, leading to intensified inflation. The US labor market remains tense, with the unemployment rate stabilizing at a low point of nearly half a century. Against this backdrop, the spiral of wage price increases seems difficult to break. Barclays Bank wrote in a research report, "If labor market conditions do not significantly relax, we still doubt whether inflation can return to the 2% target."

Finally, Chiamalis believes that after the 2008 global financial crisis, the Federal Reserve injected too much funds into the economy through the complex process of quantitative easing, and excess liquidity could lead to inflation. He said: "QE has boosted the valuation of all assets. From real estate to stocks, art and even Bitcoin, we are now in the midst of 'all foam'."

The recent information released by the Federal Reserve shows that it has not wavered in its goal of reducing inflation to 2%. But reality seems to indicate that eliminating the last point of excessive inflation and lowering it to the target interest rate of 2% is expected to be a more difficult and slow ordeal. The phenomenon of core inflation being higher than overall inflation reflects some persistent changes facing the US economy. The main factors driving up prices now are service costs - from dental care and car insurance, to various expenses such as dining in restaurants and summer concerts. These costs mainly reflect wage growth, which is often passed on to consumers at higher prices.