Inflation Has Arrived, but Washington Isn’t Racing to Limit Price Pops
Policymakers, now more attuned to the costs of choking off growth early, are sticking by a patient approach as prices rise.,
Inflation has long been the boogeyman haunting the nightmares of economic policymakers from both parties — and controlling it has been a top economic priority. But as the economy reopens from pandemic shutdowns and prices spike, it is becoming clear just how much that conventional wisdom has shifted in recent years.
After three decades of relative price stability and a long stretch of weak price gains, many economists and lawmakers had in recent years come to believe that trying too hard to avoid overheating the economy created its own risk by prematurely cooling growth and leaving workers on the sidelines.
The tools policymakers used to prevent overheating — raising interest rates and reining in government spending — also contributed to less hiring and slower wage growth. Policymakers have paid increasing attention to those trade-offs, especially as chronically slow price gains across the globe made government efforts to control inflation seem somewhere between futile and self-defeating.
That view has remained mostly intact at the Fed and the White House even as prices pop, virus variants threaten to perpetuate supply chain bottlenecks and some price increases, like rising rents, create the risk that high inflation might last for a while.
The Biden administration is emphasizing the benefits of the current moment, which include higher wages and more bargaining power for workers, as it insists that inflation will fade over time. The Fed, which meets this week, is openly nervous about rising prices, but it isn’t doing anything abrupt to counteract them. It says it needs to weigh the risk of inflation against the threat of slowing a labor market that is still missing nearly seven million jobs compared to prepandemic levels.
Republicans are decrying rising prices, warning that the administration needs to rein in its spending plans and that the Fed should withdraw support. Even some left-leaning economists have warned that things could get out of control and that central bank officials need to be on watch.
Here is a snapshot what is happening with inflation, including the risks, the rewards and how policymakers are thinking through a strange economic moment.
Prices are up this year, and pretty markedly.
Inflation is up across a range of measures, and by significantly more than economists predicted earlier this year.
The Consumer Price Index, a Labor Department gauge of how much a basket of goods and services costs to buy, rose 5.4 percent in the year through June. The Fed prefers a separate measure, the Personal Consumption Expenditures index. That gauge tracks both out-of-pocket expenses and the cost of things people consume but don’t directly pay for, like medical care. It has also moved up, climbing 3.9 percent through May.
Prices have risen by more than Fed officials expected, based on both their public statements and their economic projections from earlier this year.
Why the big jump? Some of it owes to temporary data quirks, which were expected to push inflation higher this year. Part of it has come as prices for airline tickets, hotel rooms and other pandemic-affected purchases rebound from last year, also as anticipated. But the surprisingly large part of the increase has come from a surge in consumer demand that is straining delivery routes and outstripping available supply for electronics, housing, and laundry machines.
That portion of the inflation is more tied to government policies, which put money into consumers’ pockets — and its future trajectory is a lot less predictable. Economists think the bottlenecks will fade, but by how much and how long it will take is uncertain.
Those price increases could have a downside.
Whether today’s inflation matters and warrants a response will depend on several factors.
If, as the White House predicts, quick price gains fade as the economy returns to normal, they shouldn’t be terribly problematic. Households will likely have to spend a little bit more on some goods and services but may also find that they are earning more. Workers are now seeing decent wage gains, though not quite enough to outpace price gains, and the labor market is expected to continue strengthening as inflation fades.
The biggest price gains have also been concentrated in just a few categories, like used cars. Most families do not buy automobiles that often, so the hit from higher costs will not be as salient for consumers as an across-the-board rapid rise in prices for everything consumers buy, like clothing and milk.
But if consumers and businesses come to expect higher prices and start accepting bigger price tags and demanding higher wages, that could broaden inflation and keep it elevated. That would be a problem. Rapid inflation makes life hard for people who live on savings, like retirees. If it outstrips pay gains, it can erode a consumer’s ability to buy goods and services. And if inflation becomes hard to predict, as it did in the 1970s and 1980s, it makes planning for the future hard for businesses and households.
There are risks that inflation could take time to get back to normal.
There are real reasons to worry that inflation could stick around. Supply chain snarls are expected to fade with time, but new Covid variants and renewed lockdowns in some countries could keep global trade chains from getting back to normal. That could keep prices for goods elevated. (On the flip side, Jason Furman at Harvard points out that renewed lockdowns would also probably drag down consumer demand, which could lead to softer price pressures.)
There are other hot inflation risks. Wages are rising, which might feed into faster prices as employers try to cover costs. Rents — which were depressed — are accelerating, potentially a stickier source of inflationary pressure.
If inflation becomes pernicious, the Fed has tools to contain it. The central bank is already coming up with a plan to slow its big bond purchases, which keep longer-term borrowing cheap and lift markets. It could also raise its main interest rate, which would trickle through the economy to slow lending and spending.
“One way or another, we’re not going to be going into a period of high inflation for a long period of time, because, of course, we have tools to address that,” Jerome H. Powell, the Fed chair, said during testimony this month. “But we don’t want to use them in a way that is unnecessary, or that interrupts the rebound of the economy.”
But there are also real risks to premature action.
As Mr. Powell alluded to, policymakers do not want to move too hastily in response to the recent data. Many officials argue that it does not make sense to react to what is expected to be a short-lived price pickup by dialing back fiscal ambitions or weakening monetary support — policy changes that would reduce demand and lead to slower hiring down the road.
Should the Fed pull back support for the economy before many of the 6.8 million jobs that have gone missing since the start of the pandemic return, it could lead to a painful situation in which workers end up stuck out of work.
That would cost families paychecks, hurt the country’s potential for growth and tip the economic scales toward employers, who benefit when many available workers are competing for jobs.
For decades, “the sensible adult consensus — that the most important thing was to protect against inflation — had a huge cost, and that cost was wages stagnating,” said Benjamin Dulchin, director of the organizing group Fed Up. “The Fed can err on the side of corporate interests and keeping wages lower, or it can err on the side of workers’s interests.”
Today’s inflation could offer benefits.
Inflation does have some winners. People who owe debts find that they are easier to pay off, and middle class households who own houses may find that their values appreciate. Research has suggested that inflation in advanced economies can shrink inequality, for instance.
But that isn’t even the argument the Fed and the White House are making: They simply do not expect the higher prices to last forever, and they think the short-term costs are worth the long-term benefits of helping the economy through a tough period.
Some Democrats think that voracious hiring bolstered by government spending and central bank support will give workers the power to bargain for higher wages — an ability that might last beyond the inflationary phase. And they have been trying to foster a swift recovery from the pandemic downturn, getting people back into jobs and businesses back into full swing quickly.
Officials are being patient, even as inflation surprises them.
Government officials are setting economic policy today with an eye on the last battle. After the deep 2007-9 recession, the government cut back on spending early and monetary policymakers lifted interest rates before price gains had returned to their 2 percent annual inflation goal. Price gains proceeded to get stuck below that target, and the labor market recovery may have taken longer than it needed to, since the economy had less support.
As that episode underlined, slow-moving global trends — including aging demographics and free trade — seem to keep a lid on price gains these days. In Japan and in Europe, policymakers have spent years battling to coax inflation higher. They are worried in part by the looming threat of deflation, which discourages consumption and crushes debtors, who find their pay stagnating or declining as their debt loads remain unchanged.
America’s current bout of price pressures actually seems to be helping to guide consumer expectations, which had been slipping lower, back into the comfort zone.
And a few heady inflation numbers are a good problem to have, if you ask Kenneth Rogoff, a Harvard economist. The globe just experienced a devastating pandemic that was expected to wreck the economy.
“In the current situation, the fact that the economy is booming, and they didn’t quite plan for it is still a blessing,” he said. “It’s a rich man’s problem that we’re getting inflation.”