The economy is on the path to recovery but it’s still far from repaired. Yet investors and economists are already worried it might be growing too fast. Here’s what experts actually mean when they talk about the “overheating” economy.
Just over a year ago, the US economy faced its worst downturn on record as businesses shuttered and the nation hunkered down in the face of the pandemic. Economic activity ground to a halt last spring and then rebounded over the summer.
This rebound is ongoing, but we’re not quite back to normal. For example, the size of the economy was nearly $19.1 trillion at the end of March, some $166 billion lower than it was at the end of 2019, before the pandemic hit. America is also still down more than 8 million jobs compared with February 2020.
That’s all good news. So why are some experts worried?
In a word: inflation.
Pandemic price woes
The pandemic has thrown prices for goods and services for a loop. People stopped spending money on a host of things, including traveling and dining out, as soon as the lockdowns started.
Prices in those categories plummeted while the costs of other goods skyrocketed.
Grocery stores sold out of staples and the “food at home” category of the government’s consumer price index soared. A few months later, used car prices surged as people craved mobility and but weren’t traveling by air.
Now, a lot of those price swings are normalizing as millions of Americans have received their Covid-19 vaccines and public life resumes across the country. Meanwhile, expanded unemployment benefits and direct stimulus checks for qualifying individuals are bolstering American wallets.
Make no mistake, there is still economic hardship, but people are spending more money again. And this means prices are rising.
Producers are struggling with high raw material prices and shipping costs, which might be passed on to the end consumer. Rising energy prices — US oil prices are at more than $60 a barrel — also tend to keep inflation elevated. (Last April, oil prices collapsed to below zero.)
And the data reflects those increases: In the year ending March, the Commerce Department‘s consumer spending price index rose 2.3%, its fastest pace since mid-2018. Excluding food and energy, prices rose 1.8% over the same time period.
Why worry about inflation?
Inflation has been stubbornly low for nearly a decade. The pandemic has upended this trend.
Investors and economists now worry that prices will spike too rapidly, potentially stalling the recovery. Price surges could curb consumer spending, the biggest driving force of the US economy.
Keeping prices stable is one of the main tasks of the Federal Reserve; the other is maximum employment. Some experts are concerned the Fed will respond to inflation spikes by changing its easy-money policies sooner than hoped. The stock market, for example, benefits greatly from the current low-interest-rate environment because it means companies can borrow money on the cheap.
“So with more income, more spending and more inflation in the US household sector,” the Fed could change its monetary policy stance much sooner than it is letting on right now, said James Knightley, chief international economist at ING.
The central bank’s interest rates have remained near zero since March 2020, and it buys billions of securities every month to keep markets steady. Any change to that could send shock waves across financial markets.
But so far, Fed Chairman Jerome Powell has waved off concerns about out-of-control inflation. He has said he expects prices to rise over the summer as the economy fully reopens, but normalize thereafter. The Fed targets inflation of slightly above 2% over the medium term.
Friday’s price index numbers put us on the right track for that.