How Worried Should We Be About Inflation?

High inflation is making the news, and many people are worried. On the one hand, rising prices are taking a bigger bite out of families’ wallets than they did in recent years. On the other hand, price spikes are concentrated in a few items and may prove temporary. Workers, especially low-income ones, have also seen strong wage gains that outpace price increases, so their overall standards of living are still improving. Rather than worrying about temporary, limited price spikes, policymakers should focus on keeping the labor market recovery on track, while reducing the costs of important goods and services such as health care and housing that are still unaffordable, even if they are not becoming more costly right now.

There are several reasons to worry about inflation, but three stand out. First, prices can grow faster than wages and thus make it harder for families to pay their bills. This can be particularly worrisome for low-wage workers. They have limited bargaining power and often see wage gains later in recoveries than higher-wage workers do. Second, higher inflation – faster price increases – can become a self-fulfilling cycle if workers have sufficient sway to demand higher wages to offset higher prices. In that scenario, workers receive wage increases that raise costs for businesses, which in turn increase prices again. This scenario assumes, though, that companies cannot or will not absorb higher labor costs by, for example, temporarily reducing their profits to keep their customers. Third, higher inflation can lead people to change their spending behavior in ways that drive inflation even higher. If people think that goods and services will be even more costly in the future, they will want to buy things now, before prices increase. This higher demand pushes prices up even further and sets off a vicious cycle of ever-faster price increases. All three problems are theoretically possible, but there is little evidence that they have come to pass.

For the most part, price spikes have been limited to a few items. In late spring and summer, prices rose sharply for used cars, flights, and hotels and motels. People were itching to get out and about. Eventually, inflation subsided, and prices for these items have now fallen in back-to-back months. Now, prices are instead rising for energy and certain food items. Rents are also going up, but year-over-year increases are modest and remain concentrated in a few regions, especially the Midwest and South. Yet overall, for the vast majority of what consumers buy, inflation remains relatively subdued.

Prices for other goods and items that people need are flat or rising only modestly. Prices for health care – hospitals, doctors, and prescription drugs – have risen by 0.4% for the past twelve months. Prices for some food items, vegetables, for example, were flat or below their levels 12 months earlier in September 2021. Furniture, household electronics – refrigerators, toasters and the likes — and clothing are also getting less expensive now after a surge in prices in the spring and summer. In the end, inflation without the always volatile energy and food prices grew by 4.0 percent over the past 12 months, below the overall inflation rate of 5.4%, as prices for many key items have held steady or declined.

This still leaves worries about a disparate effect of those isolated price increases on lower-income households. They spend a disproportionate share of their income on food and energy, and are also more likely to be renters than homeowners.

Yet several factors mitigate those price increases for lower-income earners. They are less likely to buy beef (which has seen its average price skyrocket) and are more likely to buy processed foods, for which prices have been flat or falling in recent months.  Average rents have risen more than six percent in Atlanta, Detroit, Tampa and St. Petersburg. But, rent increases have been less than one percent over the past year in not in New York City, San Francisco, Seattle, and the District of Columbia. On the other side of the personal budgeting ledger, workers have seen large wage increases in traditional service sectors such as hotels, restaurants, and retail outlets. Low-income families received large stimulus checks, and most families with children are getting monthly child tax credits through the end of the year. While increasing prices are certainly not helpful, real incomes have still risen for the most vulnerable Americans thanks to a combination of tight labor markets and fiscal stimulus.

Moreover, rising inflation appears to have been a temporary phenomenon. The price jumps for used cars, airline travel, hotels, and motels have already stopped. Gasoline demand typically wanes in the fall and winter as people travel less, making way for possible price declines at the pump. As the global economic recovery stabilizes, supply chain bottlenecks ease, and the pandemic subsides, disruptions in the energy market will likely diminish, again easing the way for less inflation. Rental inflation could also decline as federal, state, and local governments devote more resources to affordable housing. The signs are all pointing to decreased price pressures in the near future.

There is also no evidence of a wage-price spiral. If such a spiral were occurring, we would expect higher prices to follow the pattern of rising wages. Yet this simply isn’t happening. Restaurant workers have seen particularly large jumps in wages in recent months as people started to go out again after being cooped up for more than a year. Those wage increases, though, are largely a return to a pre-pandemic trend. Restaurants had to contend with higher wages even before everything shut down and adjust their prices accordingly. Yet, they often found ways to deal with those higher costs without accelerating inflation. Wage growth among restaurant workers started to gradually pick up in early 2014. Since then, price increases have been almost always below wage increases. Moreover, prices are going up at the same time as wages go up. None of this suggests that inflation and wages feed each other’s growth.

Finally, there is no evidence of unanchored inflation expectations. If consumers expected faster inflation to continue, they would change their behavior in noticeable ways. They would spend their money more quickly, hoard durable goods such as cars and refrigerators, and shift their savings into investments that better guard against rising prices such as housing and stocks. Instead, people are buying fewer durable goods, in part because of supply chain bottlenecks, but also possibly because they expect these particular price increases to be short-lived. And, Americans are not shifting their savings into stocks or homes. Inflation expectations are well-anchored, so they cannot sustain high inflation into the future.

The bump in inflation certainly bears watching by policymakers. But it is less worrisome than longer-term problems such as unaffordable housing, expensive medical care, and stagnant wage growth. Politicians and pundits would do better to focus on these problems instead, because unlike the bump in inflation, they will not go away any time soon.