UC Berkeley economist explains impact of inflation report and stock market selloff

The markets dropped Tuesday over concerns that inflation remains stubbornly high. The Dow fell 1,276 points or nearly 4% returning the market to its prior level in 2020.

The Consumer Price Index report by the Bureau of Labor Statistics showed costs in August rose 8.3% in the past 12 months. The core inflation without the more volatile food and gas prices was about 6.3%.

The higher-than expected inflation worries investors who anticipate that the Federal Reserve will increase interest rates.

"And so by the time we get to New Year's Day we could look at a short term interest rate of 4%," said Jim Wilcox, a UC Berkeley Professor of Finance and former Fed economist.

The Fed has already raised its benchmark interest rate four times this year, with the last two increases by three-quarters of a percentage point. The federal funds rate is currently in a range of 2.25% to 2.50%.

Higher rates hurt the economy by making it more expensive to buy a house, a car or anything else bought on credit. Mortgage rates have already hit their highest level since 2008, creating pain for the housing industry. The hope is that the Fed can pull off the tightrope walk of slowing the economy enough to snuff out high inflation, but not so much that it creates a painful recession.

At Rare Blend Cafe in Oakland, Omar, the barista puts care into each cup of coffee, but the costs have shot up for a shot of caffeine.

"Other than rent, I think everything has increased, even wages, the smallest things like toilet paper. For sure coffee has increased by a lot," said Marin Ying, co-owner of the Rare Blend Cafe.

"From our cups, to our straws...the milk has been extremely high, even our pastries, our pastries are up about 20%," said Lakeisha Holmes, who is the other co-owner of the Rare Blend Cafe.

Some of the largest year-over-year price increases in August were for food such as meat, eggs, fish, milk, fruits and vegetables and coffee.

Other goods such as new and used cars have seen prices rise.

"Trading my car in to get a used car, and it's very difficult because surprisingly the thing that used to be a little more inexpensive is so expensive," said Natasha "Nash" Ismail, an Oakland resident.

One encouraging sign was that gas prices have dropped slightly in the past month.

At the White House, President Biden touted the $750 billion Inflation Reduction Act, which experts say won't lower inflation in the short term, but will allow Medicare to negotiate lower prescription drug prices, and includes funding for energy and climate projects.

"We're going to lower prescription drug costs, lower health insurance costs, lower energy costs for millions of families," said President Biden.

"There is irony," said Wilcox, "If we do shop a bit less and save a bit more, that of course while it is sensible and prudent, in the aggregate can actually cause the recession that we're trying to guard against."

Improvements in supply chains, and further decreases in fuel, grain, and car prices could help ease inflation.

The Fed meets next Tuesday and Wednesday, and is expected to vote on those interest rates hikes to put a more immediate cool down on this hot economy.

Jana Katsuyama is a reporter for KTVU.  Email Jana at jana.katsuyama@fox.com and follow her on Twitter @JanaKTVU or Facebook @NewsJana or ktvu.com.