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How a lot fearful – and never fearful – about inflation

When it comes to economic fears, inflation is the new monster hiding under the bed. However, there is no real consensus among economists about how concerned people should be about inflation – and how likely it is that it will show up. The economy has started to warm up a bit, but inflation is not getting out of hand.

There is a small but growing chorus of economists and policy makers sounding the alarm about inflation. They warn that a combination of government incentives and the impending economic setback will cause prices to overheat. Many ordinary people might be confused by this. After all, the country is still in the midst of the Covid-19 outbreak, the economy is nowhere near normal and we still have millions of jobs ahead of our pre-pandemic time. Many economists and lawmakers have argued for months that the risk is doing too little and not too much of saving the economy. Some say a bit of inflation could be a good thing, especially given the low levels in the recent past. Indeed, the economy was deflated for parts of 2020 and prices actually fell – which could skew future numbers in the future.

“The greatest risk we face is a workforce that has been left with a long period of unemployment. People who are unemployed and cannot find work can have a permanent impact on their wellbeing. I think that's the biggest risk, "Treasury Secretary Janet Yellen said in an interview on ABC News' This Week in March. "Is there a risk of inflation? I think there is a small risk. And I think it's manageable. "

President Joe Biden and Vice President Kamala Harris will meet with Treasury Secretary Janet Yellen at the White House on March 5, 2021.

Al Drago / The New York Times / Bloomberg via Getty Images

The debate about inflation – how it works, where it is, and why – has been a longstanding debate in macroeconomics. There are always doomsday hunters warning that rapid inflation is around the corner, and there are always people telling them to settle down. Alarmists often recall the 1970s as an example of US inflation spiraling out of control and warn that a similar scenario is looming.

In recent years, the more puzzling question to many economists has been why inflation has remained so persistently low (lower than the Federal Reserve's 2 percent target) even when unemployment has fallen significantly. That makes it harder to predict what will happen next. And a lot of inflation is a game of expectation anyway.

“What is on the balance sheet is: Are we doing more on deficit spending? Are we doing more to accelerate this recovery? Or do we play it safe and let the recovery chug and reduce the risk of inflation? Said Claudia Sahm, an economist who worked for the Federal Reserve and the Council of Economic Advisers.

The conversation about inflation won't go away anytime soon, and the ideas can be difficult to analyze. Vox has addressed some of the big questions that have shaped the debate.

1) What is inflation?

To be clear, inflation is a general rise in prices. Your dollar (or any other currency) is not going as far as it used to be. It's not that a particular item gets more expensive, but that a lot of things do – bananas in the store get more expensive, so do milk and bread, shampoo and rental, and plane tickets, cigarettes and clothes, and you get what it's about.

When economists try to measure inflation, they usually create a sort of “basket” of goods and services that people typically consume and buy. There are several price indices that can be used to measure what is happening.

Probably the best known and most talked about measure of inflation in the US is the consumer price index (CPI), which measures the average change in prices urban consumers are paying for things like food, clothing, housing, and transportation. Here is a breakdown of the weighting. The Bureau of Labor Statistics offers a tool for calculating inflation based on the CPI. The Social Security Agency uses an index called CPI-W, which is price increases for urban wage earners and office workers, to calculate changes in the cost of living and determine benefits.

There are some strange facets to the CPI. For example, out-of-pocket medical expenses are accounted for, but not an increase in what Medicare pays for care. It also explains supposed "quality improvements" in ways that can be a little confusing. For example, Verizon's decision to offer unlimited cell phone data plans lowered its core CPI (that is, prices excluding food and energy) in 2017. The logic was that people would get more money for phone plans. But that doesn't mean that people's phone bills suddenly got much lower.

“It actually has some kind of intuitive sense. However, it is difficult to extrapolate what kind of quality characteristics you actually want to consider depends on what data is available to you and there are all sorts of methodological decisions that will determine whether the sticker price is actually translated into the CPI reading ” said Skanda Amarnath, director of research and analysis for Employ America, on a recent episode of Vox podcast The Weeds.

The Federal Open Markets Committee (FOMC), which sets monetary policy for the Federal Reserve, uses the Personal Consumption Spending Price Index (PCE) to rate inflation. While CPI examines what people are buying, PCE examines what companies are selling. It tends to paint a broader picture of spending and consider substituting goods when something gets more expensive. So when the price of bananas goes up, it takes into account that some people will start buying apples instead. In addition to measuring people's health care expenses, PCE also takes into account what Medicare pays.

Another terminology note: "core inflation," which, as mentioned above, means inflation minus food and energy. Food and energy prices are very volatile and can fluctuate due to factors such as oil supplies and severe weather. Hence, economists and policymakers sometimes prefer to take them out of the inflation equation to get a better sense of what is going on.

As a more specific example, consider the CPI numbers for March 2021. The index rose 0.6 percent for the month – more than 0.4 percent in February. However, the core CPI rose 0.3 percent. Last year the index rose 2.6 percent, but the core index rose 1.6 percent. In other words, depending on which economic sector you are looking at, you can tell different stories about what is happening to inflation. In March gas prices rose quite sharply, which has a significant impact on the numbers in which they were factored in.

Warm up but don't overheat # CPI + 0.6% March
Energy + 5.0% w / gas + 9.1% (1/2 headline gain)
Food + 0.1%
Core + 0.3% with protection + 0.3%
⬆️ Car Insurance, Recreation, Transp Svc, Medical
⬇️apparel, education

Headline # Inflation 2.6% YoY (~ 0.9pt)
Core inflation 1.6% (30.3pt)

– Gregory Daco (@ GregDaco) April 13, 2021

2) Why should I care about inflation?

Inflation isn't something that should keep you up at night. From the Fed's point of view, this is one such goal.

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

There are some people who set their hair on fire because of the risk of high inflation, or at least warn that it is coming. Investors are starting to say they are more concerned about inflation than the pandemic, and bond yields, often a sign that investors are expecting inflation, have risen.

Inflation is one of many measures used to measure what is going on in the economy, along with things like unemployment and wages. Low inflation can be a sign of a healthy economy. But if inflation is really picking up and your paycheck doesn't follow, that wouldn't be good. Nobody wants to pay for the same items in the supermarket anymore when they don't make more money to keep up with it. The steps policymakers could take to fight inflation or stave it off once fears arise, could also hurt the economy by cutting off growth too quickly.

The expectation of inflation is also important as these expectations can affect the behavior of companies and people. When companies believe inflation is coming, they can raise prices, which can drive inflation higher. "Inflation is one of those behavioral things that inflation takes root once everyone is worried," Coronado said.

Bottom line: Inflation is certainly something to look out for when thinking about the overall economic picture, but don't panic and stack all your money in gold and bitcoin tomorrow in case the economy explodes.

3) Where does inflation show up in the economy? Where is it not?

In recent years, many economists have asked themselves the question not whether they should be concerned about a skyrocketing rise in inflation, but rather why inflation has been so persistently low. The Fed's inflation target is said to be 2 percent, and the economy has been consistently below that for some time. In fact, the central bank is now saying that its goal is an average inflation target of 2 percent over the long term, which means inflation could go above 2 percent for a while before trying to get it under control.

“Many find it counterintuitive that the Fed wants to boost inflation. After all, low and stable inflation is essential for a well-functioning economy. And we are well aware that higher prices for essential goods such as groceries, gasoline and housing increase the burdens on many families, especially those struggling with lost jobs and incomes, "said Fed Chairman Jay Powell in prepared remarks August. "However, persistent under-inflation can pose serious risks to the economy."

Morning menu.

Why did the Federal Reserve introduce an "average inflation target" – inflation above 2% to offset some below 2%?

They finally admitted that their approach to contain economic activity when they thought 2% inflation was coming. did not work.

– Claudia FULL EMPLOYMENT Sahm (@Claudia_Sahm) March 19, 2021

Just because inflation isn't generalized doesn't mean it isn't a little high in some areas and a little low in others. Service price inflation has outperformed goods price inflation in recent years, although with the pandemic, some of them are likely to have changed temporarily. (Airfares rose before Covid-19, but when the pandemic hit, they fell. In the meantime, prices for new and used vehicles rose.) Prices in areas such as healthcare and housing have risen significantly for quite some time. Some types of inflation are particularly painful and are the focus of specific policy debates, such as: B. Prescription drug prices, especially in an aging population.

Overall, different pricing forces tend to even out in topline numbers.

"We are not seeing a general rise in inflation as rising prices in some areas are offset by falling prices in other areas," said J.W. Mason, an economist at John Jay College and a fellow at the Roosevelt Institute.

The economy has also seen some inflation in asset prices lately – you will likely have noticed that stock prices are rising, not to mention bubble-like behavior in areas like cryptocurrency and GameStop. However, this is not shown in CPI and PCE, which measure consumption rather than assets.

4) Why are people suddenly worried about inflation now?

There is significant disagreement about how concerned people should be about inflation. Before the pandemic, the unemployment rate had dropped quite a bit, to the point where typical economic thinking could have said that inflation should have increased. (Unemployment and inflation are often viewed as an inverse relationship.) But it didn't actually happen.

"We don't know what is driving inflation in today's US, and we're not sure we're modeling it properly," Mason said. "We cannot currently make policy decisions based on confident beliefs about what inflation will look like in the future."

Economists have sometimes relied on the "Phillips curve," which is a theoretical inverse relationship between unemployment and inflation, to try to find the relationship between the two forces. There has been debate about how well it held up over time. "I think the consensus is still that the Phillips curve is not dead, but the world has changed. Perhaps 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 believed the curve wasn't dead, but at least it was "resting."

Here, too, there have been long-standing debates among economists and policymakers about inflation. There is a pretty constant chorus of people warning about inflation, and there is even a subset of inflation truths that say inflation is already there and we miss it.

A major cause of concern over the past few weeks and months has been the amount of incentives the federal government has put in place in response to the pandemic. It's more than $ 6 trillion so far – that's a lot.

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

Some economists and experts have warned that it is too much and that once the economy recovers – perhaps pretty quickly thanks to the vaccine – the country will not have enough capacity to meet demand and the economy will overheat, resulting in one Price increase leads. Sure, inflation has been low for some time, they say, but it could change quickly.

"Inflation could be a bigger threat precisely because it is no longer perceived as such. Policymakers want to push it further. Most households and businesses are not concerned about the risks. Once the pandemic has subsided, those risks will no longer be entirely downside, ”former New York Fed President Bill Dudley wrote in a December inflation warning issued by Bloomberg.

Moody's analytics economist Mark Zandi also warned that investors might underestimate inflation. "Inflationary pressures will move very quickly," he told CNBC in March.

Both the White House and the Fed have tried to address concerns and want the economy to get better – and jobs to return – before worrying it will be too good.

"Prices fell sharply last spring when the pandemic spiked," Yellen told ABC News in March. “I expect some of these prices will rise again as the economy recovers in the spring and summer. But that's a passing price move. "

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

The Fed uses the federal funds rate – the interest rates banks charge other banks – as one of their primary tools to influence the economy. If it keeps the interest rate low, which will make borrowing cheaper across the economy in the hopes that it will boost borrowing and spending – businesses will invest and hire more workers, consumers will not hold back from buying that new car. When it increases the rate, it slows things down, makes borrowing more expensive, and in turn, causes spending to slow down.

If inflation rises, the Fed can try to fight it by raising interest rates, which are now near zero. It increases the federal rate for banks and they pass those increases on to their customers. As people and businesses face higher interest rates on borrowing, they reduce their spending, which helps keep prices under control. "It seems like a small roundabout because it's a small roundabout," Mason said. "One way or another, you reduce spending in the economy, you reduce GDP growth, and that ultimately leads to lower inflation."

During the Great Recession, the Fed cut interest rates to zero to fight the recession. From 2015 onwards, they were gradually increased again, with the idea that interest rates had to be “normalized” so that they could be lowered again in the event of another recession. Some people have criticized the move, arguing that it slowed economic growth unnecessarily in order to contain inflation. It is not clear that this was ever in sight. It's a tricky balancing act: the Fed's goal is to keep unemployment low and inflation in check.

However, it appeared that unemployment could turn out much lower than expected without causing inflation. The idea of ​​“full employment” is that unemployment gets so low that basically anyone who can work works, which then drives up wages. Whatever that full employment marker really was, the US didn't hit it.

The Fed cut rates back to zero when the pandemic hit, and now, Powell said, it has no intention of raising rates anytime soon, at least until the economy looks a lot better and a few more. In addition, millions of people – women – have left the workforce and will take time to get back into work.

6) Can Inflation Be Good?

Inflation that is out of control and creates an uncontrollable upward spiral in prices is bad. It would be quite painful because people's paychecks would not keep up with the prices and would be worth less for their money. Should that happen, the actions the Fed could take to combat it could push the country into 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, not zero.

Inflation has different effects on different people, Sahm said. One of the most common examples is savers versus borrowers. If you have a fixed rate mortgage, which means that the interest rate on your home loan is set at a certain level, inflation isn't bad business for you. "Inflation for debtors makes it a little easier for them to repay debts," said Sahm. "On the other hand, people who have made these loans, savers, that is bad for them. When the loan is repaid, it means less what that creditor can buy and reinvest."

Increased inflation is usually accompanied by higher interest rates, and this gives the Fed room to cut interest rates when there is a recession or economic downturn. Modest inflation is also a way to avoid deflation – which means prices will go down – which sounds good, but is often a sign of a weakening economy and means that debt is getting more expensive.

For workers, inflation means whether wages are keeping up. Part of what the Fed is aiming for now is for unemployment to get so low – and possibly some inflation to pick up – that the labor market gets so tight that wages start to rise. "What the Fed is looking for is wage growth that sustains some inflation, slightly higher inflation, and that will be a good sign for them that the economy is working close to full employment," Coronado said.

Of course, rising wages with inflation cannot be taken for granted. "If anything, wages have historically lagged inflation, so certain categories of workers can lose if inflation rises faster," Mason said. He pointed out another wrinkle on the wage front: there are some economists who argue that modest inflation can be helpful in situations where certain companies or sectors need wages declines but do not want to cut them immediately.

7) What are some worst case inflation scenarios?

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

Prices keep rising, 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 are rushing to convert their pesos to dollars knowing the currency is unstable. The country has a double exchange rate: the “official” rate and the black market rate known as “blue”. Right now the official rate is around 90 pesos to the dollar, the blue around 140. If paid in dollars, this is good business. If you're paid in pesos it sucks and prices go up much faster than wages. Consumers pay for things in a range of interest-free installments when they can, assuming everything is likely to be much more expensive soon.

But here's the thing: America is not Argentina, which has its own unique economic and political challenges that don't really compare to the US. The same goes for Venezuela, another country that people often fear about.

As for the US, the worst scenario most people point out is the 1970s when the US economy experienced a persistently high period of inflation. It is often described as an era of "stagflation". Inflation was accompanied by economic stagnation, which meant that growth was slow and unemployment was high. The average inflation rate over the decade was over 6 percent, and at times the economy hit double-digit inflation. The decade saw other economic shocks such as the skyrocketing oil price and President Richard Nixon's end of the convertibility of the dollar to gold. The US only gained control of the situation after the Fed took tough measures in the early 1980s that drove the economy into recession.

Some economists are currently concerned that the US could be headed for an inflationary period in the 1970s, in large part due to the federal government's response to the pandemic, most recently to President Biden's $ 1.9 trillion Covid-19- Auxiliary law.

Larry Summers, an economist who served in both the Bill Clinton and Barack Obama administrations, is among the loudest voices warning of possible high inflation. In a recent interview with Bloomberg, he said what is happening now is "the least responsible fiscal macroeconomic policy we have had in 40 years". He believes that there will be a third chance for the US to experience inflation and stagflation in the years to come, and that there is also an equal chance that there will be no inflation because the Fed is putting on the brakes and the equal chance that there will be growth without inflation.

Economists agree that inflation would be bad in the 1970s. Where they disagree is how likely it is. Nobel laureate economist Paul Krugman told Bloomberg that the Fed had "simple" tools to fight inflation and that he did not expect them to replicate the "seriously, seriously irresponsible monetary policy" of the 1970s.

8) Is the worst case scenario the most likely scenario?

In a word, no. There is reason to be vigilant – as policy makers say – but not to panic.

"I'm not as worried as some," said Doug Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office. "We don't want to see extreme inflation hikes because if they happen suddenly and there is no time to adjust, people will be hurt, and they know it. But I don't think that's in the cards."

The scenario the country is in now isn't a 1970s copy either. And, as Mason pointed out, there is a lot more economic history – including recent history – as a precedent for what might happen now: "We've been telling stories about the 70s for a long time, but the 70s were a long time ago, and it was ain't the only thing that ever happened "

Chairman Powell has said he expects a brief "pop" of inflation, but the Fed wants to avoid an overreaction. "When we see what we think is a temporary spike in inflation where longer-term inflation expectations are broadly stable, I assume we'll be patient," he said in March.

That doesn't mean that the Fed wouldn't react if something went wrong, or that Powell and Yellen might not be wrong in their predictions. But the end of the world is not the most likely scenario on the horizon or near. Even Summers only gives his worst-case prediction a one-on-three chance of actually happening.

Schönle warned that it is important to separate short-term and long-term dynamics. Until 2020, the history of the economy was one thing, but there was a major economic disruption last year due to the pandemic. In a way, what's next is going to be a lesson. “How we get out of this unusual situation will show us how the economy adapts. Everything happened very quickly, ”he said. "Fortunately, we don't see these situations very often."

9) If inflation happens, can we fight it?

Policy makers have made it very important to note that if inflation rises too high, there is an opportunity to get it under control. The White House and Fed realized that if the federal government did too little to help people get back to work and afloat financially, they were more concerned about the possible long-term damage to the economy to stay as that they temporarily increase demand.

“Inflation has been very low for over a decade. You know, it's a risk, but it's a risk that the Federal Reserve and others have tools to deal with, ”Yellen told CNBC in February. "The greater risk is scaring people. We have this pandemic that is permanently affecting their lives and livelihoods for life."

If inflation rises too quickly, the Fed can raise interest rates to try to slow things down. This means that consumers could see higher interest rates on items like car loans and credit cards. Auf der anderen Seite verdienen sie etwas mehr mit ihren Ersparnissen.

Es ist eine Frage des Timings – es besteht das Risiko, dass die Fed zu früh reagiert, wenn noch mehr Potenzial vorhanden ist, und das Wachstum etwas zu früh abschneidet. Es besteht auch das Risiko, dass es zu lange wartet und die Inflation außer Kontrolle gerät. Aber auch dies scheint nicht das wahrscheinlichste Szenario zu sein.

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