If you’ve tried to buy just about anything from groceries to airline tickets lately, it’s no surprise that prices are on the rise. But many analysts were taken aback when the Bureau of Labor Statistics released its Consumer Price Index (CPI) earlier this week showing prices jumped 4.2 percent in April over a year ago, a much sharper spike than the 3.6 percent economists expected.
Even when staples like food and energy, commodities that fluctuate in price month to month, were taken out of the CPI equation, prices are up 3 percent since 2020 and rose 0.9 percent just between March and April, something that hasn’t occurred since 1982. Price hikes and dips are a routine fact of free market economies. But when they rise abruptly or approach levels that hinder consumer spending, inflation can trigger all sorts of knock-on effects, which could spell trouble for the U.S. economic recovery.
Alberto F. Cavallo, Ph.D. ’10, Edgerley Family Associate Professor of Business Administration at Harvard Business School, studies the macroeconomic policy and measurement implications of price fluctuations in economies around the world. Since early 2020, he’s been focused on how COVID has affected consumer prices, drawing on spending data from Opportunity Insights, a research initiative run by Harvard economist Raj Chetty. Cavallo spoke with the Gazette about what’s driving prices up, how far they may still go, and what COVID has revealed about the U.S. economy.
Alberto F. Cavallo
GAZETTE: In March 2020, at the very onset of the pandemic, you argued that consumers were experiencing a higher rate of inflation than the CPI was capturing. So is this 4.2 percent rate increase since April 2020 genuinely new and surprising, as many have suggested? And why are prices rising sharply when demand is up and many industries seem to have adapted to COVID?
CAVALLO: Since last year, I’ve been investigating this issue of the measurement of inflation during COVID. COVID dramatically changed the way we did our spending, during the lockdowns in particular. The CPI is constructed in a way that the weights assigned to each category of consumption are not updated often. During 2020, we were still using the weights assigned in 2019, and that meant [it] did not correctly reflect the actual experience of higher inflation people had through March of 2020. But that was a temporary measurement problem. The weights were updated in December of 2020.
It’s not a new thing that happened in the last couple of months, as the official statistics reflect. Some people, particularly low-income people, have actually experienced higher levels of inflation for several months. Food inflation has been particularly high during COVID, and traditionally, low-income households spend relatively more on food.
Why are we seeing more inflation right now? There are basically three factors. One is the so-called “base effects.” The Bureau of Labor Statistics calculates an annual inflation rate [by] compar[ing] prices today to prices 12 months ago. Twelve months ago, we were in the middle of the crisis; prices were falling. In the official CPI, they were particularly low, so the annual inflation rate appears higher right now. That probably increases the annual inflation rate by roughly one percentage point. If we didn’t have that, we would be closer to three percent. Still, that’s a temporary effect. It’s not the whole story.
[Consumers] are seeing more inflation right now because of two other factors: supply disruptions and demand, which is picking up. No one can actually measure supply disruptions at the retail level, so we have been monitoring the number of “stock outs” online at large retailers. We built these time series that measure temporary stock outs, which are when the website shows “this item is out of stock,” but it’s supposed to be coming back. And then, we are measuring what we call permanent “stock outs,” which is when the item completely disappears from the stores. What we find is that we had a spike in temporary stock outs in April of 2020. The temporary stock outs went from about 15 percent of all items in the store, which is the normal level we were seeing before the pandemic, to over 25 percent. And then there was a gradual decline over time. We seem to be going back to normal in terms of how many of these items are temporarily out of stock. But what is surprising is how many items have disappeared from [retailers’] websites altogether. They’re not even offered for sale. The total number of products or varieties of products have fallen by about 20 percent relative to what we saw pre-pandemic. The Fed has emphasized that they expect the supply disruptions to stop putting upward pressure on prices in the next few months. They’re proving more persistent than many people expected, me included. As soon as vaccinations started, I thought [there’d be] faster recovery in some of the supply disruptions. I expect now, based on the research we have done, that they will continue having an impact for at least one quarter more or even longer. I do expect them to eventually dissipate or improve towards the end of the year.
The final factor is demand, which is recovering very quickly. Nobody knows what will happen with demand in the future. It will depend a lot on how the Fed and also the Treasury react to higher levels of inflation, if it persists toward the end of this year.
GAZETTE: Prices for certain categories of goods that went up at the onset of the pandemic (real estate, food, energy, construction materials and services, large appliances, home furnishings, automobiles) remain high, while those categories that nosedived early on (air travel, hotels, restaurants, and live entertainment) are rebounding pretty significantly. Why are prices up across so many different sectors?
CAVALLO: At the beginning of the pandemic, we had competing forces. We had some sectors that were experiencing more demand temporarily because of the lockdowns and some sectors where demand was collapsing — hotels, transportation — all those prices were falling. There were also some sectors experiencing supply disruptions. You had supply pushing prices up, and demand pushing it down and so, prices were, if you will, contained.
Many firms are operating still with a lot of additional costs. Think of restaurants, for example. They can accept new customers, but many restrictions of social distancing still remain. They can occupy only half of their tables. They’ve been having these higher costs ever since we have been able to go back to restaurants, and demand is picking up. At the same time they’re still facing some of the supply disruptions. So all of these forces are coming together and pushing prices up. That’s what’s special about this moment we’re living right now: We have supply disruptions; we have demand pushing prices up; and we have some of these temporary base effects, creating the impression that inflation has been rising very quickly — in part because of what’s happened in the last few months, but also, because we’re comparing [it] to a very depressed price level back [in 2020].