Posted 9:25 a.m. Tuesday, July 27, 2021

The cost of items like lumber and gas are increasing. The big question is whether these prices will stay high.

UW-La Crosse economist talks about increased cost of gas, lumber and just about everything

If you’ve recently pulled up to the pump, started a home construction project, or bought food, you may have noticed that prices look high. Is the price of everything going up? Will these inflated prices ever go down? UW-La Crosse Professor and Economist John Nunley answers these questions and more.  

1. Are prices going up on everything?  

The price of goods and services has risen by about 5.4 % from June 2020-June 2021. If we exclude the price changes in food and energy, which tend to have more volatile price changes, prices have risen by about 4.5% over the last year.  

In modern times, this is a pretty big increase in price levels. It is the largest year-over-year change since November 1991. Prices started to rise around January 1, 2021.  

2. Are the increases more dramatic than we've seen in the past? 

The U.S. had extremely high core inflation rates in the 1970s. (Core inflation includes the price change of everything except food and energy). But since the 1990s, core inflation has been hovering around 2.0-2.5%.  

3. Is the price change transitory or a permanent shift to higher prices?  

No one really knows the answer to this. So, the short answer is it has been worse in the past, but over the last 25-30 years, we haven't seen core inflation rates this high.  

4. Why are prices going up?  

It is a combination of things.  

  • As the pandemic comes to end (maybe?), people are starting to do more things such as going out to eat and traveling. So, demand for goods is currently rising and that is putting upward pressure on prices.
  • The pandemic led to supply disruptions such as meat packing plants that had to close because of super spreader events. Once inventories are back to where they should be, the Federal Reserve Board posits that prices will revert to back to normal levels.

5. Why are gas prices rising?  

I think the main reason is that oil prices have been rising. Oil is a key input to make gasoline. So, when oil becomes more expensive, gasoline prices rise due to higher production costs. When the pandemic hit, demand for gasoline and, hence, oil collapsed. This lowered the price of both goods. So, as the pandemic ends, demand for gas/oil begins to rise. But it takes a while for supply to adjust to the greater demand. A driver of lower oil supplies comes from the Organization of the Petroleum Exporting Countries or OPEC (a cartel that decides how much oil to pump out of the ground). Members of OPEC and Russia have been cutting their extractions. So, less oil supply means higher oil prices, which means higher gasoline prices.  

6. Why are lumber prices going up?  

First of all, lumber prices fluctuate more than those of many other goods. This is because sawmills have limited capacity. Homebuilding, renovations and related work can increase or decrease, but the sawmills are unable to easily adjust to higher demand.  

Lumber is actually in abundant supply right now. So, what we are most likely experiencing is short-run fluctuations in supply and demand. During the pandemic, many people who could not vacation or do other things, took on home projects. Also, storms hit all across the U.S., a cohort larger than the boomers starting their careers (the millennials), and low interest rates encouraged home buying/building. All of these things point to greater demand for lumber, which will result in higher prices.  

Supply is also a problem. Mills find it difficult to hire workers (often located in rural areas where populations are declining). In addition, trucking companies need drivers and they are having a hard time finding people as well. These things by definition lower their capacity. Likewise, COVID outbreaks have closed down mills and other building-related production units. 

So, if I had to guess, prices will come down when demand wanes. It's hard for me to see supply increasing enough to lower lumber prices.  

7. What sectors are we seeing the most increase in prices?  

Building materials and energy-related goods are key areas that are seeing a rise in prices. These goods tend to have more volatile prices. So, it is likely these sectors of the economy would be affected the most by inflation. Health care is an example of something that likely won't be affected too greatly by the disruptions we are seeing. With health care, you would not expect to see the big increases in demand like we are seeing for autos/gas/lumber.  

8. Are these prices likely to fall again?  

It depends on who you ask. The key question relates to how much of the increase in prices is transitory vs. permanent. Let's assume the inflation rate is 10%. If half of it is transitory, then we have a big problem. A 5% increase in the price level is problematic. However, if 3/4 of it is transitory, then the FED is right at its target inflation rate of about 2-2.5%. The FED believes prices will come down to more normal level, but that it might take one to two years. Other prominent economists, such as a Larry Summers, believe that inflation is likely more permanent than transitory. Time will tell. I am concerned about it being permanent, but I recognize that it might not be.  

If prices don't cool in the next year or two, we will then know it wasn't transitory. We are in unchartered territory with the pandemic, recession, stimulus payments and more. It's really hard to predict how things will play out.  

9. What is the inflation rate? 

Two common methods for measuring inflation include the Consumer Price Index and the personal consumption expenditures price index.  The federal reserve board uses personal consumption expenditures inflation measure.  

10. What is a healthy inflation rate?  

Over the last couple of decades, the FED's goal has been a 2% inflation target. So, as you can see, we are over that at present.  

11. Is the inflation we are seeing good or bad or both?  

Inflation is not in itself bad. Actually, deflation (prices going down) is worse than inflation. The concern is that prices will start rising too fast. This type of thing can spiral out of control. The U.S. had out -of -control inflation in the 1970s. Germany did in the early 1920s, when it was cheaper to burn deutsche marks than wood.