That’s not the same dramatic price hike we saw at the start of the coronavirus pandemic as consumers panicked and bought toilet paper and hand sanitizer. Rather, May’s rise may signal that we are entering a period of inflation – a continued rise in the cost of living – likely triggered by the gradual restart of the economy after the abrupt shutdown in March 2020.
Inflation is not inherently good or bad. Kept in check, it’s the sign of a healthy economy. It keeps us spending instead of hiding our money under a mattress. But while inflation has remained stable in recent decades, some worry that current prices will continue to rise to the point where consumers will come under pressure, undermining the economic recovery.
Here are five important things you should know about inflation and whether you should be concerned about it:
1. What is inflation?
Simply put, inflation is a sustained increase in consumer prices. It means that a dollar bill won’t get you as much as it used to, whether you’re at the grocery store or in a used car parking lot.
Inflation is usually driven by either increased demand – such as COVID consumers finally getting ready to leave their homes and spend money – or supply-side factors such as increases in production costs.
Inflation is a long-term thing. And it takes some historical context to make sense.
For example, in 1985, the cost of a movie ticket was $3.55. These days, watching a movie at the theater will easily set you back $13 for the ticket alone — let alone the popcorn, candy, or soda. A $20 bill in 1985 would set you back nearly four times as much as you buy now.
In the past century, there have been only a few years when annual inflation in the US has been negative. But we also measure inflation in the near term, where we can see sharper increases, like the ones we saw for April.
2. How do we know if we are in a period of inflation?
Inflation is not a physical phenomenon that we can observe. It’s an idea backed by a consensus of experts who rely on market indices and research.
One of the most closely monitored indicators of inflation is the Consumer Price Index, which is compiled by the federal Bureau of Labor Statistics and based on the diaries of urban shoppers. CPI reports track data on 80,000 products, including food, education, energy, medical care and fuel.
The BLS also compiles a producer price index, which tracks inflation more from the perspective of consumer goods manufacturers. The PPI measures changes in seller prices reported by industries such as manufacturing, agriculture, construction, natural gas and electricity.
And there’s also the Personal Consumption Expenditure Price Index, prepared by the Bureau of Economic Analysis, which is usually a broader measure because it includes all goods and services consumed, whether purchased by consumers, employers, or federal programs on behalf of the consumer. .
In May, the Department of Labor announced that the CPI had risen 5 percent in May, following a 4.2% rise in April — the rise that first caused a stir among market watchers. Some specific market segments are experiencing even more dramatic price increases: the used car and truck index shot up 10% in April.
But that rise in the CPI in itself does not mean that we are necessarily in a cycle of rising inflation. That’s where the Fed comes in.
3. How the Federal Reserve Can Fix Things?
Founded in 1913, the Federal Reserve is the control center for the U.S. banking system and administers the country’s monetary policy. Run by a board of governors, it also consists of a Federal Open Market Committee and 12 Federal Reserve banks established in different regions.
While the BLS reports on inflation, the Fed moderates inflation and employment figures by managing the money supply and setting interest rates. Part of its mission is to keep average inflation at a constant rate of 2%; it’s a delicate balancing act, and the main lever it can pull is to adjust interest rates. In general, when interest rates are low, the economy and inflation grow. And when interest rates are high, the economy and inflation slow down.
The Fed considers the recent increases in inflation to be “transient” and attributes the “strengthened” economic activity and employment data to coronavirus vaccinations and related policies. In April, Federal Reserve vice chairman Richard Clarida said prices “will likely rise a little further before slowing down later this year” and warned they could even exceed the 2% target. But he called them “one-time raises.”
“I expect inflation to return to — or perhaps slightly above — our longer-term target of 2% in 2022 and 2023,” Clarida said in a speech in May.
4. What about the other ‘flations’?
There are a few other “flations” worth knowing about. Let’s refresh:
As the name implies, deflation is the opposite of inflation. Economic deflation is when the cost of living falls. (We saw this in parts of 2020, for example) Widespread deflation can have a devastating impact on an economy. In US history, deflation has often been accompanied by economic crises. Deflation can predict an impending recession, as consumers tend to stop buying in the hope that prices will continue to fall, causing demand to fall. Ultimately, this leads to consumers spending even less, lower wages and higher unemployment rates.
This economic cycle is similar to inflation in that it involves an increase in the cost of living. However, unlike inflation, hyperinflation is happening quickly and has gotten out of hand. Many economists define hyperinflation as the price increase of 1,000% per year. Hyperinflation is uncommon in developed countries like the US. But do you remember Venezuela’s economic collapse in 2018? That was partly due to inflation in the country reaching over 1 million percent.
Stagflation is when the economy enters a period of stagnation. In these cases, unemployment is high, prices are rising and economic growth is slow. Stagflation was first recognized in the 1970s after the energy crisis. At the same time, inflation doubled, the US experienced negative GDP growth and unemployment reached 9%. Memories of this dark economic time play a role in the current fear of inflation spiraling out of control, even though the circumstances are very different.
5. Should we be concerned?
No – not yet anyway. While you are seeing the cost of everyday living rising, this is likely the normal and expected response to the stalled pandemic economy. There is no consensus among experts that inflation will become an ongoing cycle. It’s just on their radar, especially as Capital Hill weighs in on some massive economic stimulus packages and the economy is making a comeback.
But take comfort in the fact that the Fed has been behind us lately; the economy has been consistently at or below the inflation target of 2% for nearly a decade. So let the Fed do the worrying (at least about inflation) for you. That’s his job.
Michelle Meyers and Justin Jaffe contributed to this report.