The warnings that higher inflation lurks around the corner are starting to show up everywhere.
They are appearing in some business surveys, with companies looking to raise prices as they prepare for a post-pandemic economy. They are showing up in the bond market, where price moves in the last few months imply that big-money investors expect consumer prices will start to rise faster. And they are apparent in the news media, from magazine covers to financial news segments.
But inflation itself is not showing up: The Consumer Price Index in December showed only a 1.4 percent rise in what Americans paid for goods and services over the last year. And top Federal Reserve officials made clear in recent days that they (still) viewed too-low inflation as the bigger risk to the economy, not soaring prices.
High inflation causes its own sort of pain, as the purchasing power of money falls. But persistently low inflation is a worry, too, often a reflection of weak growth and stagnant wages — the predominant problem for the United States and other advanced economies for more than a decade.
How can one reconcile the inflation talk — and in some quarters, alarm — with the absence of actual inflation? It’s easier than you might imagine.
It helps to think of not a single inflation risk ahead, but of four distinct ones. In terms of significance, these range from mere statistical anomaly to a huge shift in the global economy. In terms of likelihood, they also range from near certainty to completely speculative.
Each of these four inflations has different implications, both for how ordinary people making economic decisions should react to them, and how policymakers, particularly at the Fed, should approach their work in the months and years ahead. One of the concerns is that policymakers will conflate one inflation risk with another, which could lead to bad decisions, either choking off a recovery prematurely or, on the flip side, allowing a 1970s-style vicious cycle of inflation to take hold.
It can be hard to tease these things out in real time, but some simple metaphors can help. If we start to see higher prices later in the year, the first thing to ask is: Is this a yo-yo effect; a story of hungry bears emerging from hibernation; the result of excess water sloshing around a bathtub; or a balloon finally being reflated after years of leaking air?
The yo-yo effect
The spring of 2020 was weird in countless ways. And that means the economic data in spring 2021 will also be weird in countless ways.
The price of many goods and services collapsed between March and May, as much economic activity shut down. In many cases, those prices have recovered to close-to-normal levels, but in the arithmetic of annual inflation, that won’t matter. Even if the basic trend line of the price of those items is reasonably stable, the reported year-over-year inflation will be extraordinarily high.
If, for example, the overall Consumer Price Index rises through May at a rate…
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