Transitory inflation is a term that was widely used in 2021 by Federal Reserve and Biden administration officials to describe higher-than-normal prices that emerged during the Covid-19 economic crisis.

After slashing rates to zero to aid the economy, the Fed adopted a new monetary policy strategy in late 2020 to let inflation run hotter than its long-term goal of 2% a year.

As the pandemic eased in 2021, Covid vaccines became widely available and the economy began reopening in fits and starts. At the same time, supply chain bottlenecks started piling up everywhere.

Take these factors, add in thousands of dollars in direct stimulus payments to tens of millions of Americans throughout 2020 and 2021, and you had a recipe for big, broad-based price gains throughout the U.S. economy.

U.S. government officials initially described the price increases as “transitory,” since they believed inflation would soon revert to a more normal course. But as time passed and higher inflation became entrenched in the economy, the term “transitory” was retired.

What Is Transitory Inflation?

Inflation is the increase in prices over time throughout an economy. Higher prices reduce the purchasing power of consumers. That means that each dollar you own buys fewer goods and services.

The concept of transitory inflation was used to describe price gains that were expected to be temporary and not part of a long-term trend. This term has been used in the field of economics and academic research, but it was only in 2021 that it spilled out into the broader national conversation about the economy.

The American Institute of Economic Research defined transitory inflation as a rate of inflation that does not remain high permanently. In some cases, the temporary high inflation rate is followed by a period of lower inflation.

As noted above, the Fed targets an inflation rate of 2% over the long term, as measured by the core personal consumer expenditures price index (PCE). However, inflation rates can fluctuate in the near term, higher and lower than this target rate.

For example, supply chain issues can cause prices to rise. If the price levels increase for a relatively short period of time, the inflation is described as “transitory.”

With transitory inflation, price levels don’t continue to increase at the same rate. Eventually, the increase is slowed. That doesn’t mean prices return to pre-inflation levels; the prices of consumer goods are still high, just the rate of change in inflation decreases.

The Fed Promised Inflation Would be Transitory

In the spring of 2021, the Fed was forced to confront a problem the country had not experienced in decades: really high inflation.

The consumer price index (CPI) increased at an annualized rate of 4.2% in April, the highest level in almost 13 years. By May, the year-over-year increase had risen to 4.9% before increasing to 5.3% in June.

Fed Chair Jerome Powell and other Fed officials told Americans not to worry. They argued that high inflation was due to a series of weird circumstances, such as supply chain issues and comparisons to 2020 when economies were shut down.

Plus, the trendline was driven by a few goods, such as used cars, and it was not-broad based. According to Powell, soon everything would go back to normal.

“[T]hese one-time increases in prices are likely to have only transient effects on inflation,” Powell said in March 2021.

Treasury Secretary Janet Yellen, for her part, expected inflation to drop by the end of the year. That was the conventional wisdom among most economists at the time.

They were all wrong.

Inflation Was Anything But Transitory

Annual CPI inflation remained around 5.3% through September 2021, before jumping to more than 7% by December. Six months later it would be over around 9%, a four-decade high.

Meanwhile, price increases affected every American household budget. Food, energy and shelter were all dramatically more expensive than a year prior.

Perhaps most worryingly for the Fed, wages dramatically picked up throughout 2022. More pay furthers demand for goods and services, which only increases inflation.

Workersvaren’t feeling flush, however, since inflation-adjusted earnings are down 3% compared to this time last year.

To his credit, Powell realized he had erred, and by the end of 2021 he was preparing the market for higher interest rates. The Fed has raised the fed funds rate four times so far in 2022, from zero to 2.25% to 2.5%.

Markets expect the Fed to hike rates by at least another percentage point before the end of the year.

Powell and the FOMC also engaged in quantitative tightening (QT) in a bid to increase longer-term interest rates. Bond prices and yields are inversely related. By increasing the supply of long-term bonds, Powell hopes to lower their price and thereby cause the yields to go up.

The dramatic shift to a hawkish policy demonstrated that higher prices were much more entrenched, and wide-spread, than experts believed in 2021.

Transitory Inflation Causes

What can cause the short-term inflation spikes associated with transitory inflation? There are a few key factors that can cause inflation rates to rise.

  • Supply chain issues. One of the most common causes of transitory inflation is supply chain disruptions. The COVID-19 pandemic highlighted how vulnerable global supply chains are. A shortage in one area can quickly cause prices to rise in another. Political tensions, weather events and other unforeseen issues can also lead to transitory inflation.
  • Global factors. Transitory inflation can also be caused by global factors. For example, the Russian invasion of Ukraine caused energy and food prices to skyrocket after the West foisted sanctions on Russia.
  • Government interventions. There are other reasons transitory inflation can occur. For example, if the government implements stimulus measures or there’s an increase in government spending, it can lead to transitory inflation.

Inflation, particularly transitory inflation, can be affected by a range of factors, and can be difficult to predict.

Inflation’s Impact on the Economy

In June 2022, the U.S. Bureau of Labor Statistics announced that the CPI had risen 9.1% over the past 12 months, the largest increase in 40 years.

The June CPI report capped months of four-decade highs in CPI, which has convinced many observers that inflation is anything but transitory.

In an attempt to curb price increases, the Fed has hiked its main interest rate, the federal funds rate, four times in 2022, and will likely continue to do so throughout the year.

Fed interest rate hikes make borrowing money more expensive, causing businesses and consumers to spend less money. As rates increase, economic activity slows, which hopefully can help reduce inflation.

To protect your finances against inflation—transitory or not—consider adopting these measures:

  • Trim your budget. When inflation is on the rise, it’s important to take a close look at your budget and find ways to trim expenses. For example, cancel subscriptions, swap out ingredients for cheaper substitutes in meals and reduce your reliance on air conditioning or heat to lower energy costs. Budgeting apps can help you better manage your money and cut corners.
  • Look for ways to increase your income. If possible, increase your earnings by picking up a side gig, selling unused items or working overtime. Boosting your income can make it easier to deal with higher inflation rates.
  • Shop around. You can save money by shopping around for auto or homeowners insurance. Plan on shopping around at least once a year to ensure you’re not overspending.
  • Pay down debt. As rates rise, interest rates on credit cards and adjustable-rate loans will also increase. You can reduce the impact of rising inflation and save money by making extra payments toward your debt. You can use the credit card repayment calculator to design a debt payoff strategy.
  • Invest your money. Rising inflation highlights the importance of investing for the long-term. Your money will earn only a very small annual percentage yield (APY) in a savings account; increased inflation actually makes your money worth less. Investing in a diversified portfolio will help your money grow, though you need to be patient. And with investment apps, investing is easier than ever.