Inflation is high and has been for months. It’s weighing on consumer confidence, making policymakers nervous and threatening to eat away at household paychecks well into 2022.
This is the first time many adults have experienced meaningful inflation: Price gains had been largely quiescent since the late 1980s. When the Consumer Price Index climbed 7% in the year through December, it was the fastest pace since 1982.
Naturally, people have questions about what this will mean for their pocketbooks, their finances and their economic futures.
Closely intertwined with price worries are concerns about interest rates: The Federal Reserve is poised to raise borrowing costs to try to slow down demand and keep the situation under control.
To bring some clarity to a complicated situation, we collected more than 600 reader questions, narrowed them down to a handful that reflected common themes, and asked top economists and experts — from the White House, the Federal Reserve, Wall Street, academia and financial advisory firms — to weigh in. Here is what they had to say.
— Readers want to know what caused inflation, and what might come next.
Q: What would cause prices to keep increasing vs. staying at their current level? Why wouldn’t competition keep prices in check? — Nick Altmann, Chicago
Prices have been rising for two basic reasons: Consumers are buying a lot of goods and services, and supply is limited.
Consumer demand is the easier part of that equation to explain. Households saved money during long months of lockdown in 2020, often helped by repeated government stimulus checks and other payments. Some saw their wealth further buoyed by a rising stock market and soaring home prices. Now, jobs are plentiful and wages are rising, further shoring up many families’ finances. People have money, and they want to spend it on services and, more than usual, on goods like furniture and camping gear.
That rapid consumption is running up against constrained supply. Factories shut down early in the pandemic, and in parts of Asia, they continue to do so as omicron cases surge. There aren’t enough containers to ship all of the goods people want to buy, and ports have become clogged trying to process so many imports.
As companies have struggled to get their hands on enough goods to go around, many have raised prices, in many cases to cover their own climbing costs. Some, noticing that they and their competitors were able to charge more without crushing consumer demand, have tested how far they can push up prices — expanding their profits.
In theory, competition should eat away at extra earnings over time. New firms should jump into the market to sell the same products for less and steal away the customer. Existing competitors should ramp up production to meet demand.
But this may be an unappealing time for new firms to enter the market. Established companies may be hesitant to expand production if doing so would involve a lot of investment, because it is not clear how long today’s strong demand will last.
“It is a very uncertain environment,” said Matthew Luzzetti, chief U.S. economist at Deutsche Bank. “A new firm stepping in is a lot of investment, with a lot of financial risk.”
Until companies can produce and transport enough of a given product to go around — as long as shortages remain — companies will be able to raise prices without running much risk of losing customers to a competitor.
Q: In past periods of inflation, did employers typically increase wages or award higher-than-average yearly increases to help employees offset inflation? If so, in what industries is this practice most common? — Annmarie Kutz, Erie, Pennsylvania
There is no standard historical experience with wages and inflation, Mary C. Daly, president of the Federal Reserve Bank of San Francisco, said during an interview with The New York Times on Twitter Spaces last week.
Wages did increase sharply alongside inflation in the 1970s and 1980s, but in the decades since, pay has struggled to keep pace with price increases. Factors like unionization, worker bargaining power and the state of the labor market all affect whether companies pay more. Those can vary quite a bit by sector. For instance, lower-wage service industries have been competing mightily for workers in recent months, and pay is climbing faster there.
“The history isn’t so clear that cost of living translates into higher wages, but that’s largely because inflation has been low and stable for a very long time,” Daly said.
— Many are curious about how it will affect their personal finances.
Q: Is inflation a valid reason for asking for a raise (or a larger raise than I would otherwise receive)? In addition to other merits (work performance, role change, etc.), does my reduced purchasing power due to inflation give me ground to stand on when negotiating my new salary? — Deirdre Kennedy, St Paul, Minnesota
Several economists and advisers agreed: Higher prices can be a valid reason to ask for a raise.
“Absolutely sit down with your boss and say, ‘I’m a great performer, I do this work, I want to stay with the company but it’s been harder and harder to make ends meet and I would like to talk about some compensation to make that easier,’ ” Daly said last week.
Q: I’m 55 and on track to have put aside enough for a modest but workable retirement in 10-15 years. How much less might my savings and investments be worth in the face of current trends? I’m concerned I won’t have enough time to bounce back if it gets really bad and that higher prices will eat up my resources long before I die. — Jon Willow, Interlochen, Michigan
There’s good news here: Hardly any economists or policymakers expect today’s inflation to last. Fed officials in December projected that price gains will drop back below 3% by the end of the year, and will level off to normal levels over the longer term.
That’s a reason to avoid reacting too swiftly, advisers said. But if you do worry inflation will last, there are a few ways to assess how it might affect your savings, said Christine Benz, Morningstar’s director of personal finance.
She recommended that investors take a look at their sources of income. Social Security and many government pensions are adjusted for inflation, so those should keep pace with price gains. Bonds that pay back fixed rates do less well during periods of inflation, while stock investments — though riskier — tend to rise more quickly than consumer prices. Benz recommends holding assets across an array of securities, potentially including inflation-protected securities such as some exchange-traded funds or Treasury Inflation Protected Securities, commonly called TIPS.
“It argues against having too much in cash,” Benz said. “That’s too much dead money.”
— Readers wonder how government policymakers will react.
Q: We currently have low unemployment, strong wage growth (largely through attrition/voluntary retirements), easy monetary policy and now rising inflation. What are other periods of time when the United States had these conditions? How did things work out then? — Harshal Patel, Moorestown, New Jersey
Jared Bernstein, a member of the White House Council of Economic Advisers, pointed to the post-World War II period as a reference point for the present moment.
“Demand was strong, and supply was constrained,” he said. “That’s a very instructive path for us.”
The good news about that example is that supply eventually caught up, and prices came down without spurring any greater crisis.
Other, more worried commentators have drawn parallels between now and the 1970s, when the Fed was slow to raise rates as unemployment fell and prices rose — and inflation jumped out of control. But many economists have argued that important differences separate that period from this one: Workers were more heavily unionized and may have had more bargaining power to push for higher wages back then, and the Fed was slow to react for years on end. This time, it’s already gearing up to respond.
Q: Why are price controls thought to be a highly disfavored response to inflation? — Jim Moher, San Leandro, California
In the 1970s, President Richard Nixon tried wage and price controls — which put a cap on how much pay can rise — to control inflation. The freezes worked for a time, but prices rocketed up when they were lifted, and they got a bad rap among economists. That reputation has haunted them ever since. We asked experts about price controls in a recent article, and vocal minority think the 1970s experience unfairly tarnished the idea and that it might be worthwhile to reopen the debate.
“This is a great suppressed topic,” said James K. Galbraith, an economist at the University of Texas. “It was absolutely mainstream from the start of World War II until the Reagan administration.”
Q: If inflation is being caused by supply chain problems, how will raising interest rates help? — Larry Harris, Ventura, California
Kristin J. Forbes, an economist at the Massachusetts Institute of Technology, said a big part of today’s inflation ties to roiled supply chains, which monetary policy can’t do much to fix.
But trade is actually happening at elevated levels even amid the disruptions. Factories are producing, ships are shipping, and consumers are buying at a rapid clip. It is just that supply is not keeping up with that booming demand. Higher interest rates can relieve pressure on demand, making it more expensive to buy a boat or a car, cooling off the housing market and slowing business investment.
“A good part of the supply chain problems, you can’t do anything about,” Forbes said. “But you can affect demand. And it is the combination of the two which determines inflation.”
[This article originally appeared in The New York Times.]