Climbing commodity prices, ambitious government spending packages due to the COVID-19 pandemic, and the subsequent economic crash have resurrected a long-dormant fear: runaway inflation. But what is inflation, and is it something to worry about? A lot of the thinking surrounding inflation has changed over the years, and economists disagree on what causes it and how much weight the federal government and Federal Reserve should give it when it sets fiscal and monetary policies. Here’s a closer look:
What is Inflation?
The Dangers of High Inflation
A Drop in Real WagesWhen prices rise more quickly than wages, real incomes drop.
Poor households, with few tangible assets, are more vulnerable than affluent households that own property and other inflation-resistant investments.
Economic UncertaintyWhen businesses don’t know what future costs will be, they make fewer capital investments, slowing down the economy.
Less Competitive Domestic GoodsRunaway inflation can cause the nation’s consumers to buy more imported goods and foreign consumers to buy fewer of the country’s exports.
Rising UnemploymentAs prices increase, businesses may try to reduce costs by employing fewer people.
Should We Worry About the Current Rate of Rising Inflation?
As the economy reopens, inflation has shot up. Economists disagree over whether that’s cause for alarm. That’s partly because the last few decades have challenged the conventional wisdom on inflation.
Low unemployment rates have historically been associated with high inflation, although this link began to deteriorate in the late 1980s. And following the Great Recession, inflation remained almost obstinately stable against fast jobs gains. While some economists see big government spending, low interest rates, and hordes of post-pandemic American consumers eager to spend as a recipe for disaster, others are less concerned.
The reasons they give are varied. Stable inflation over the last few decades may signal that central banks have mastered monetary policy, making it less likely in general for inflation to get out of control. Perhaps the current spike in inflation will be a temporary issue, as the economy snaps back to pre-pandemic levels of activity. Some argue that even if high inflation represents a real economic risk, the risk of keeping so many unemployed and without economic relief is far greater.
Inflation is a fact of modern economic life. When it’s kept below a manageable threshold, it can be a good thing. It’s hard to predict what the economy will look like as a patchwork of countries begin opening back up. However, you can expect that inflation will remain a hot topic of discussion as the economy finds its new normal.