The US has room for inflation to go even higher

Surging gas prices are raising concerns that rapidly rising inflation could derail the US economic recovery. Inflation hit 7.9% on an annual basis in February on the back of higher oil prices, and that’s without taking into account the full effect of Russia’s invasion on Ukraine.

But Americans are in a good place to withstand even higher prices for oil and other goods. Between pandemic government aid and the economic recovery, they’ve accumulated some extra cash. Meanwhile, the economy overall is less dependent on oil, so the higher prices won’t do as much damage as in the past.

And in the long run, high prices tend to cure high prices as consumers pull back on spending.

Here’s what will help the American economy cope with rising inflation:

The US economy can afford higher prices

Omicron showed that US households have some built-up resilience to weather shocks, said Lauren Melodia, deputy director of macroeconomic analysis at the Roosevelt Institute. Up until recently, wages had been rising, allowing Americans to save more, especially those on the low-income part of the spectrum. Both savings and consumer spending held steady while layoffs stayed low despite disruptions from omicron.

The US is more resilient to shocks in oil production

The US produces more oil and is more energy efficient than it was 15 years ago during the oil shock that was part of the 2008 crisis, said George Pearkes, an investment analyst at Bespoke Investment Group.

“In our modern economy, oil is both ubiquitous and increasingly less important,” Pearkes said. “If you compare the differences between the volume of oil we’ve consumed as a country to total inflation adjusted economic output, it’s gone down dramatically over the last 40 years.”

Having more oil produced in the US also means that oil producers add more to gross domestic product (GDP), and make up for some of the losses from households cutting  back on spending.

“There was a time when really high oil price inflation could’ve tipped us into a recession by clamping down on household spending,” said Josh Bivens, research director at the Economic Policy Institute. “But our oil extraction sector is pretty huge now… and they generate a ton of domestic profit now.”

Stagnating wages mean inflation will temper

The US Federal Reserve had feared that rapidly rising wages would translate into inflation that feeds on itself,  spiraling out of control. But that scenario seems less likely now as wage growth stalls.

That might lead the Fed to hike interest rates less than anticipated this year, especially if high oil prices have a chilling effect on demand for durable goods like cars. Durable goods weigh heavily on core inflation — the Fed’s preferred method of looking at inflation by stripping out gas and food prices.

This means that even if oil prices rise higher, the Fed is unlikely to tip the US into a recession with too many interest rate hikes.

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