“U.S. inflation is highest in 13 years as prices surge 5%”. This Wall Street Journal headline from last week is representative of a widespread concern that 1970s-style inflation — with its 13% rates on home mortgages, large spikes in gasoline prices and general economic malaise — is lurking around the corner.

Should we be worried? Not yet, but let’s add some context first.

Textbook explanations of modest inflation treat it as a neutral phenomenon: Everything measured in dollars goes up by the same rate — wages and prices — so it’s not a big deal if your groceries and rent go up by 5% when your wages also increase by the same 5%. 

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This no-big-deal view of inflation is reflected in the Federal Reserve’s publicly stated target of 2.0% average inflation over the foreseeable future. The government wants some inflation. Not a lot, but enough to avoid falling prices which has its own set of problems. The story changes when prices start rising dramatically and rapidly as in Argentina and Venezuela, but those are the rare exceptions and the U.S. is nowhere close to having those kinds of headaches. 

It is also helpful to understand how the government measures inflation. Ignoring some technical details, inflation is computed in the following way: First, based on surveys of consumer spending, the government comes up with a list of goods and services that is representative of everything purchased by the American consumer, a mega shopping cart for the typical U.S. household. 

Every month, thousands of government workers check at stores and businesses around the country to get tens of thousands of prices for all the items in that shopping cart. This data is then used to compute a weighted average price for the cart for that month: big ticket items like home mortgage payments or rental rates get a large weight while things like haircuts get smaller weights. The change in the price of that list — the Consumer Price Index or CPI — is the standard measure of inflation.

The prices within the CPI are influenced by macro and micro factors. For instance, maybe a pipeline shuts down, causing gasoline price spikes in Georgia. Perhaps vacationers stop booking hotel rooms in Las Vegas because of COVID-19, sending room rates to record lows. The reasons behind changing prices vary tremendously, and yet the CPI just lumps prices together into a single monthly number. Government actions do affect prices, but it is tough to predict or measure the effect of any given policy action on inflation. There are too many things going on.

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Which brings us back to our original question: should we be worried about inflation? Two points to consider:

  • The 5% annual inflation number is calculated from a pandemic-induced low point for the CPI. In May 2020, businesses were shut down and folks were staying home. Despite shortages of toilet paper and cleaning supplies, overall, prices were down. This makes the year over year comparison unusually high and not very helpful in predicting future inflation. 
  • Emergency actions by the government — stimulus checks, low interest rates, expanded unemployment benefits, etc. — has created a lot of buying power for households. Additionally, government mandates, safety precautions, and snarled supply chains have increased costs for many firms. In this environment, firms have more flexibility to raise prices. 

A short-term jump in prices is not surprising given the circumstances. But the pandemic will pass, as will the emergency government actions. This will weaken the upward pressure on prices. 

However, if the federal government keeps spending trillions of dollars with the Fed accommodating that expenditure by buying up U.S. debt, we might enter an inflation spiral. So the massive budget and spending bills being considered in Congress do risk turning a temporary blip into a long-run problem. 

Right now, markets believe that future inflation will bounce in the 2.0%–2.5% range. Individuals and firms are not building in significant inflation into their wage and supply contracts. If that changes, then we are in trouble. When you demand at least a 5% salary increase to keep up with the cost of living, and your boss says sure, then we’re back to the ’70s. Until then, we can be cautiously optimistic that the current spike in prices will have a shorter lifespan than the pandemic.

Professor Mark H. Showalter is chair of the economics department at Brigham Young University.