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How much to worry — and not worry — about inflation

9 questions about inflation you were too afraid to ask.

The US Treasury building in Washington, DC, seen from outside its fence.
The US Treasury building in Washington, DC.
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Emily Stewart covers business and economics for Vox and writes the newsletter The Big Squeeze, examining the ways ordinary people are being squeezed under capitalism. Before joining Vox, she worked for TheStreet.

When it comes to fears about the economy, inflation is the new monster hiding under the bed. But there isn’t a real consensus among economists about just how concerned people should be about inflation — and how likely it is to show up on a sustained basis. The economy has started to get a little warmer, but inflation isn’t spiraling out of control.

There’s a smallish but growing chorus of economists and policymakers sounding the alarm about inflation. They warn that a combination of government stimulus and the impending economic snapback will cause prices to overheat. A lot of regular people might be confused by this. After all, the country is still in the middle of the Covid-19 outbreak, the economy is far from back to normal, and we’re still millions of jobs short from where we were pre-pandemic. Many economists and lawmakers have spent months arguing that the risk is doing too little, not too much, to save the economy. Some say a little bit of inflation may be a good thing, especially given how low it’s been in the recent past. Indeed, for parts of 2020, the economy saw deflation and prices actually fell — which could distort more current numbers going forward.

“The most significant risk we face is a workforce that is scarred by a long period of unemployment. People being out of work, not able to find jobs, can have a permanent effect on their well-being. I think that’s the most significant risk,” Treasury Secretary Janet Yellen said in an interview on ABC News’s This Week in March. “Is there a risk of inflation? I think there’s a small risk. And I think it’s manageable.”

President Joe Biden and Vice President Kamala Harris meet with Treasury Secretary Janet Yellen on March 5, at the White House.
Al Drago/The New York Times/Bloomberg/Getty Images

The debate about inflation — how it works, where it is showing up, and why — is a longstanding one in macroeconomics. There are always doomsayers warning that rapid inflation is around the corner, and there are always people telling them to settle down. Alarmists often hark back to the 1970s as an example of US inflation spun out of control, warning that a similar scenario might be on the horizon.

But in recent years, the more puzzling question for many economists has been why inflation has remained so stubbornly low (lower than the Federal Reserve’s 2 percent target), even when unemployment fell significantly. That makes it harder to predict what’s going to happen next. And a lot of inflation is an expectations game, anyway.

“What hangs in the balance is: Do we do more in terms of deficit spending? Do we do more in terms of speeding up this recovery? Or do we play it safe and let the recovery chug along and lower the risk of inflation?” said Claudia Sahm, an economist who has worked at the Federal Reserve and the Council of Economic Advisers.

The conversation about inflation isn’t going away anytime soon, and the ideas can be hard to parse. Here are some of the big questions shaping the debate.

1) What is inflation?

To put it plainly, inflation is a general rise in prices. Your dollar (or whatever currency) doesn’t go as far as it used to. It’s not that a specific item gets pricier but that a bunch of things do — bananas at the store become more expensive, and so do milk and bread, and shampoo and rent and airline tickets and cigarettes and clothes and, well, you get the point.

Usually, when economists are trying to measure inflation, they create a sort of “basket” of goods and services people typically consume and buy. There are multiple price indexes out there that seek to measure what’s going on.

Probably the best-known and most discussed measure of inflation in the US is the Consumer Price Index (CPI), which measures the average change in prices paid by urban consumers for things like food, clothes, housing, and transportation. You can see a breakdown of how it’s weighted here, and the Bureau of Labor Statistics offers a tool to calculate inflation based on CPI here. The Social Security Administration uses an index called CPI-W, which is price increases for urban wage earners and clerical workers, to calculate cost-of-living changes to determine benefits.

The CPI has some weird facets to it. For example, it takes into account out-of-pocket medical expenses but not, say, an increase in what Medicare pays for care. It also accounts for supposed “quality” improvements in ways that can be a little confusing. For instance, Verizon’s decision to offer unlimited cellphone data plans pushed down core CPI (meaning prices excluding food and energy) in 2017, the logic being that people would get more bang for their buck on phone plans. But that doesn’t mean people’s phone bills suddenly became much lower.

“It actually has a sort of intuitive sense. But it is challenging to extrapolate that, what kinds of things for quality are you trying to actually account for depends on what data you have available, and there’s all sorts of methodological choices that determine whether you’re actually going to see the sticker price translate into the CPI reading,” said Skanda Amarnath, director of research and analysis at Employ America, on a recent episode of the Vox podcast The Weeds.

The Federal Open Markets Committee (FOMC), which sets the Federal Reserve’s monetary policy, judges inflation by the personal consumption expenditure (PCE) price index. While CPI looks at what people are buying, PCE looks at what businesses are selling. It tends to capture a broader picture of spending and contemplates substitution among goods when something gets more expensive — so if the price of bananas goes up, it takes into account that some people will start buying apples instead. PCE doesn’t just measure people’s out-of-pocket costs for health care, it also contemplates what Medicare is paying.

One other terminology note: “core” inflation, which, as mentioned above, means inflation minus food and energy. Food and energy prices are quite volatile, and they can swing based on factors such as oil supply and severe weather, so sometimes economists and policymakers prefer to take them out of the inflation equation to get a better sense of what’s going on.

For a more concrete example, consider the CPI numbers for April 2021. The index was up 0.8 percent for the month — more than the 0.6 percent increase in March. And Core CPI was up 0.9 percent. Compared to a year ago, the index was up 4.2 percent — a big jump — but the core index increased by 3 percent. When you get rid of food, gas, and used cars (the price of which increased by 10 percent over the course of a month), year-over-year inflation was 2.6 percent. In other words, depending on which segment of the economy you’re looking at, you can tell different stories about what’s happening with inflation.

Energy prices, overall, are up 25 percent over the past year, including nearly 50 percent for gas. These numbers are from April, so they don’t reflect any increases from the oil pipeline that was shut down by a cyberattack.

2) Why should I care about inflation?

Inflation is not something that should be keeping you up at night. That’s sort of the goal, from the Fed’s standpoint.

“Below a certain level, people generally don’t have to worry about it,” said Julia Coronado, a former economist at the Fed and the founder of MacroPolicy Perspectives, an economic research firm. “Some prices go up, some prices go down; on balance, your wages keep going up with your overall cost of living, and you don’t have to think about it. That’s the Fed’s objective: that inflation is so low that people don’t have to think about it in their daily lives.”

There are some people setting their hair on fire about the risk of high inflation, or, at the very least, warning that it’s coming. Investors are beginning to say that they are more worried about inflation than the pandemic, and bond yields, often a sign that investors expect inflation, have gone up.

Inflation is one of many measures to gauge what’s going on in the economy, along with things like unemployment and wages. A small amount of inflation can be a sign of a healthy economy. But if inflation really starts to pick up and your paycheck doesn’t follow, that wouldn’t be good. Nobody wants to pay more for the same items at the grocery store if they’re not making more money to keep up with it. The measures policymakers might take to combat inflation, or to stave it off once fears rise about it, could harm the economy too by cutting off growth too fast.

The expectation of inflation also matters because those expectations can affect how businesses and people behave. If businesses think inflation is coming, they might increase prices, and that can push inflation up. “Inflation is one of those behavioral things that, once everybody starts worrying about it, that’s when inflation takes root,” Coronado said.

Bottom line: Inflation is certainly something to pay attention to when thinking about the broader economic picture, but don’t panic and pile all your money into gold and bitcoin tomorrow just in case the economy explodes.

3) Where is inflation showing up in the economy? Where isn’t it?

Over the past several years, the question many economists have been asking themselves isn’t whether they should be worried about inflation skyrocketing but instead why inflation has been so persistently low. The Fed’s inflation target is supposed to be 2 percent, and the economy has consistently run below that for quite some time. In fact, the central bank now says its goal is an average inflation target of 2 percent over the long term, meaning it might let inflation run over 2 percent for a while before trying to get it under control.

“Many find it counterintuitive that the Fed would want to push up inflation. After all, low and stable inflation is essential for a well-functioning economy. And we are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes,” Fed Chair Jay Powell said in prepared remarks back in August. “However, inflation that is persistently too low can pose serious risks to the economy.”

Just because inflation isn’t showing up broadly doesn’t mean it’s not a little high in some areas and a little low in others. Price inflation in services has outpaced price inflation in goods in recent years, though with the pandemic, some of that’s changed, probably temporarily. (Airfares were going up before Covid-19, but once the pandemic hit, they plummeted. Meanwhile, the price of new and used vehicles went up.) Prices have increased significantly in areas such as health care and housing for quite some time. Some types of inflation are particularly painful and become the focus of specific policy debates, such as prescription drug prices, especially with an aging population.

Different price forces, in aggregate, tend to balance one another out in topline numbers.

“We don’t see rising inflation across the board because rising prices in some areas are being offset by falling prices in other areas,” said J.W. Mason, an economist at John Jay College and fellow at the Roosevelt Institute.

The economy has also seen quite a bit of asset price inflation recently — you’ll probably have noticed that stock prices are on the rise, not to mention bubble-like behavior in areas such as cryptocurrency and GameStop. But this doesn’t show up in CPI and PCE, which measure consumption, not assets.

4) Why are people suddenly worried about inflation now?

There’s considerable disagreement about how concerned people should be about inflation. Before the pandemic, the unemployment rate had fallen by quite a bit, to the point that typical economic thinking would have said it should have caused inflation to rise. (Unemployment and inflation are often thought to have an inverse relationship.) But it didn’t really happen.

“We don’t know what drives inflation in the contemporary United States, and we’re not sure we’re modeling it the right way,” Mason said. “We can’t make policy choices right now based on any kind of confident beliefs about what inflation is going to be in the future.”

Economists have sometimes relied on the “Phillips curve,” which lays out a theoretical inverse relationship between unemployment and inflation, to try to figure out the relationship between the two forces. There’s been debate over how well it’s stood up over time. “I think the consensus is still the Phillips curve isn’t dead, but the world has changed, so maybe the way it works has changed,” said Raphael Schoenle, deputy director of the Center for Inflation Research at the Federal Reserve Bank of Cleveland. In a 2018 interview, Powell said he believes the curve may not be dead, but it is at least “resting.”

Again, there are longstanding debates among economists and policymakers about inflation. There’s a pretty consistent chorus of people warning inflation is just around the corner, and there’s even a subset of inflation truthers who say that inflation is already here and we’re missing it.

One major catalyst for concern in recent weeks and months has been the amount of stimulus the federal government has undertaken in response to the pandemic. Thus far, it amounts to more than $6 trillion — which is a lot.

“We are in a historic moment; we have a very activist fiscal and monetary policy stance,” Sahm said. “This is a whole new world.”

Some economists and experts have warned that it’s too much, and that once the economy recovers — perhaps rather quickly, thanks to the vaccine — the country won’t have enough capacity to meet demand and the economy will overheat, resulting in an increase in prices. Sure, inflation has been low for a while, they say, but it could quickly turn around.

“Inflation might be a greater danger precisely because it’s no longer perceived as such. Policy makers want to push it higher. Most households and businesses are not concerned about the risks. Once the pandemic abates, those risks will no longer be entirely on the downside,” Bill Dudley, former president of the New York Fed, wrote in December in a Bloomberg op-ed warning about inflation.

Moody’s Analytics economist Mark Zandi has also cautioned that investors might be underestimating inflation. “Inflationary pressures will develop very quickly,” he told CNBC in March.

Both the White House and the Fed have sought to tamp down concerns, saying they want to see the economy get better — and jobs come back — before they start to worry about it getting too good.

“Prices fell a lot last spring, when the pandemic surged,” Yellen told ABC News in March. “I expect some of those prices to move up again, as the economy recovers in the spring and summer. But that’s a temporary movement in prices.”

One major question is whether price increases will be “transitory” — as in, come and go — or whether they’ll stick. The Fed is predicting the former, but it’s also keeping an eye out for the latter. Indeed, inflation ticked up a bit in April, but we still have to wait to see what happens in May, June, July, etc.

5) What does inflation have to do with interest rates set by the Fed?

The Fed uses the federal funds rate — the interest rate banks charge other banks — as one of its primary tools to influence the economy. When it keeps the rate low, that makes borrowing cheaper across the economy, the hope being it will boost borrowing and spending — businesses will make investments and hire more workers, consumers won’t hold off on buying that new car. When it increases the rate, it slows things down, making borrowing more expensive and in turn triggering a slowdown in spending.

If inflation increases, the Fed can try to combat it by increasing interest rates, which are now near zero. It raises the federal funds rate for banks, and they pass those increases on to their clients. As people and businesses face higher interest rates for borrowing, they cut back on spending, which helps get prices under control. “It seems a little roundabout because it is a little roundabout,” Mason said. “One way or another, you’re reducing the amount of spending in the economy, you’re reducing the growth of GDP, and that’s what eventually leads to lower inflation.”

During the Great Recession, the Fed cut interest rates to zero to try to combat the recession. Starting in 2015, it began to increase them gradually again, the idea being that it needed to “normalize” rates so that it could cut them again if another recession emerged. Some people have criticized the move, arguing it unnecessarily stunted economic growth in an attempt to curb inflation it’s not clear was ever on the horizon. It’s a tricky balancing act: The Fed’s goal is to keep unemployment low and inflation in check.

But it appeared unemployment could go much lower than the conventional wisdom anticipated without causing inflation. The idea of “full employment” is that unemployment gets so low that basically everybody who can is working, which then drives wages up. Whatever that full employment marker really was, the US wasn’t hitting it.

The Fed cut interest rates back to zero when the pandemic hit, and now, Powell says it has no intention of increasing interest rates in the near future, at the very least until the economy looks a whole lot better and then some. Moreover, millions of people — namely, women — have dropped out of the workforce, and it will take some time to get them back in.

6) Can inflation be good?

Runaway inflation that results in an uncontrollable upward spiral of prices is bad. It would be quite painful, because people’s paychecks would not keep up with prices, and their money would be worth less. If it were to happen, the measures the Fed might take to try to combat it could push the country into a recession.

However, when it comes to modest inflation, the story is a little more complicated. After all, there’s a reason the Fed’s target inflation rate is 2 percent and not zero.

Inflation has different effects for different people, Sahm explained. One of the most common examples is savers versus borrowers. If you have a fixed-rate mortgage, meaning that the interest rate on your home loan is set at a certain level, inflation isn’t a bad deal for you. “Inflation, for debtors, makes their life a little easier paying back debts,” Sahm said. “On the other side of it, people who have made those loans, savers, that’s bad for them. When the loan gets repaid, it’s going to mean less in terms of what that creditor can go and buy and reinvest.”

Increased inflation is usually accompanied by higher interest rates, and that gives the Fed room to cut interest rates if there is a recession or economic downturn. Modest inflation is also a way to avoid deflation — meaning prices go down — which might sound nice, but it’s often a sign of a weakening economy, and it means debts would become more expensive.

As for workers, what inflation means is a question of whether wages keep up. Part of what the Fed is seeking now is for unemployment to get so low — and perhaps some inflation to pick up — so that the labor market gets so tight that wages start to rise. “What the Fed is looking for is wage growth that underpins some inflation, somewhat higher inflation, and that will be a good sign to them that the economy is operating close to full employment,” Coronado said.

To be sure, wages rising with inflation isn’t a given. “If anything, historically, wages have lagged behind inflation, so certain categories of workers can lose when inflation is rising more rapidly,” Mason said. He pointed to another wrinkle on the wage front: There are some economists who argue that modest inflation can be helpful in situations where certain firms or sectors need wages to fall but don’t want to cut them outright.

7) What are some worst-case inflation scenarios?

I spent most of 2008 to 2014 in Argentina, a country that is one of the examples of hyperinflation people often invoke to scare others about the dangers of inflation. The inflation situation there has been pretty bad for years.

Prices are constantly going up, to the point that restaurants sometimes just write menu prices on stickers, and cash isn’t really worth saving, at least not in pesos. People and businesses rush to convert their pesos to dollars because they’re aware the currency is unstable. The country has a dual exchange rate: the “official” rate and the black market rate, known as the “blue.” Right now, the official rate is about 90 pesos to the dollar, the blue is about 140. If you’re paid in dollars, it’s a good deal. If you’re paid in pesos, it sucks, and prices are going up a lot faster than wages. Consumers pay for stuff in a bunch of interest-free installments when they can because the assumption is everything will probably be way more expensive soon.

But here is the thing: America is not Argentina, which has its own set of unique economic and political challenges that aren’t really analogous to the US. The same goes for Venezuela, another country people often raise fears about.

In terms of the US, the worst-case scenario people most often point to is the 1970s, when the US economy experienced a sustained period of high inflation. It’s often described as an era of “stagflation”; inflation was accompanied by economic stagnation, meaning growth was slow and unemployment was high. The average inflation rate across the decade topped 6 percent, and at times, the economy hit double-digit inflation. The decade also saw other economic shocks, such as skyrocketing oil prices and President Richard Nixon ending the dollar convertibility to gold. The US only gained control of the situation after the Fed took severe measures that pushed the economy into a recession in the early 1980s.

What some economists are worried about right now is that the US might be headed toward a ’70s-like period of inflation, due in large part to the federal government’s response to the pandemic, most recently President Biden’s $1.9 trillion Covid-19 relief bill.

Larry Summers, an economist who served in both Bill Clinton’s and Barack Obama’s administrations, is among the loudest voices warning about potential high inflation. In a recent interview with Bloomberg, he said that what’s happening now is “the least responsible fiscal macroeconomic policy we’ve had for the last 40 years.” He said he believes there’s a one-third chance the US will see inflation and stagflation in the years to come, saying there’s also the same chance there’s no inflation because the Fed hits the brakes, and the same chance that there will be growth without inflation.

Economists agree that ’70s-level inflation would be bad; where they don’t agree is how likely it is. Nobel laureate economist Paul Krugman told Bloomberg that the Fed has “easy” tools to address inflation, and he doesn’t foresee it replicating the “seriously, seriously irresponsible monetary policy” of the 1970s.

8) Is the worst-case scenario the likeliest scenario?

In a word, no. There’s reason to stay vigilant — as policymakers say they are — but not reason to panic.

“I’m not as alarmed as some other people are,” said Doug Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office. “Extreme increases in inflation are something we don’t want to see, because if they happen abruptly and there isn’t time to make adjustments, people are going to get hurt, and they know that. But I don’t think that’s in the cards.”

The scenario the country is in now also isn’t a carbon copy of the 1970s. And as Mason pointed out, there’s a lot more economic history — including more recent history — to look to as precedent for what might happen now: “We’ve been telling stories about the ’70s for a long time, but the ’70s was a long time ago, and it’s not the only thing that’s ever happened.”

Chair Powell has said he expects a short “pop” in inflation, but the Fed wants to avoid overreacting. “If we do see what we believe is likely a transitory increase in inflation, where longer-term inflation expectations are broadly stable, I expect that we will be patient,” he said in March.

That doesn’t mean the Fed wouldn’t react if things go awry, or that Powell and Yellen might not wind up being wrong in their predictions. But doomsday isn’t the most probable scenario on the horizon, or close to it. Even Summers gives his worst-case prediction only a one-in-three chance of actually happening.

Schoenle cautioned that it’s important to separate short-term and long-term dynamics. Leading up to 2020, the story on the economy was one thing, but over the past year there’s been a major economic disturbance because of the pandemic. In a way, what comes next will be a lesson. “How we leave this unusual situation is going to teach us how the economy adjusts. Everything has happened very quickly,” he said. “We don’t see these situations, fortunately, very often.”

9) If inflation happens, can we fight against it?

Policymakers have been quite emphatic that if inflation picks up too much, they have the ability to get it under control. The White House and the Fed have been clear that they’re more concerned about the potential long-term damage to the economy if the federal government does too little to help people get back to work and stay afloat financially than they are a temporary surge in demand.

“Inflation has been very low for over a decade. And, you know, it’s a risk, but it’s a risk that the Federal Reserve and others have tools to address,” Yellen told CNBC in February. “The greater risk is of scarring the people, we having this pandemic take a permanent lifelong toll on their lives and livelihoods.”

If inflation starts to increase too quickly, the Fed can increase interest rates to try to slow things down. That means consumers could see higher interest rates on items such as car loans and credit cards. On the flip side, they’ll earn a little more on their savings.

There is some question of timing — there’s a risk the Fed reacts too soon, when there’s still more potential, and cuts off growth a little too early. There’s also the risk that it might wait too long and inflation could get beyond its control. But, again, that really doesn’t seem like the likeliest scenario.

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