What’s the inflation rate? Why are some economists worried about it? And how do interest rates set by the Federal Reserve tie in? 9 questions about inflation, answered.
9 questions about inflation you were too afraid to ask. 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.” 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.
