It is time to write about inflation again, although I allocated three columns to the subject in 2021. The first, in April, argued that inflation was a distant threat compared to the still sluggish economy recovery. With the passing of months, newer data confirmed that the economy was in worse shape than it then appeared, but also that inflation worsened faster than I expected. The second column, in August, explained some of the deep challenges economists faced in analyzing inflation. That was a column that pushed the need for humility in our understanding of when and how bad inflation could get. The third column, in October, noted the rising price level that was clearly apparent to shoppers.

To be clear, from April to October there were plenty of reasons to anticipate higher prices for goods and services. Federal stimulus payments put money into households and businesses, and the pandemic forced savings to an all-time high. Last spring, household savings were two-trillion dollars higher than the previous year, foretelling a flurry of spending.

Over the summer, families and businesses spent like crazy on everything from vacations to recreational vehicles and new homes. This caused what many called ‘supply chain’ interruptions. In reality, U.S. factory production hit inflation-adjusted record levels, while imports broke all previous records. Supply chains moved more products than ever before, and they just couldn’t meet the demand from all that pent up savings.

When people want to buy more of something than you can supply, the prudent business person raises prices. Similarly, when many businesses wish to hire you, the prudent worker demands a higher salary. That is how we first see the inflation that now appears in monthly inflation data.

To be clear, the monthly inflation data is not as bad as a year-over-year comparison would make it seem. Recall that we experienced deflation in 2020, so the two-year average increase in prices is a bit more muted than the scary headlines. However, that sober and factual analysis doesn’t count for much in the grocery checkout line.

By mid-winter 2022, a significant share of that household savings is spent, lessening the urgent demand for goods that we had last summer. That is now showing in the data, with inflation for goods slowing modestly, while inflation for services has risen. That signals that price inflation is also affecting wages because labor costs dominate services.

A short-term shock to prices is not usually something that has long-term adverse effects on the economy. Neither would a one-time price increase that remained permanently. Both of these happen to different products from time to time. The deep worry about inflation is that it will be lasting, so the increase in prices each month will compound on themselves. This week I saw the first sign of that prospect.

INside Indiana Business reported that Viewrail, a manufacturing firm in Goshen, was offering cost-of-living adjustments to its employees through 2022. They called this an inflation protection plan that would insure their workers were protected from a loss in their purchasing power. While this is good for both the employees and the company, it signals that inflation expectations are creeping into contracts. Or, at the very least that this employer is concerned about losing employees.

To be fair, Viewrail claimed that this was out of concern for employees, and I don’t dispute the motives of these employers. I’d simply note that if they are worried about inflation and wages, surely a large number of other employers are as well. If businesses raise prices or wages due to last month’s inflation, the problem becomes self-perpetuating, and slowing inflation becomes very difficult. Doubtless the Federal Reserve is now seeing similar warnings across much of the nation.

The next scheduled meeting of the Federal Reserve’s Open Market Committee is in March. With recent data suggesting stronger underlying economic conditions accompanied by higher inflation, it seems certain they will raise rates. Two months ago, the casual conversations among economists was that there might be a 25 basis points (25 percentage point) increase in March. Now most of those I speak with anticipate a 50 basis point increase, and at least one member of the rate setting committee has been reported to favor a full percent increase.

One interesting aspect of inflation is how it affects Americans differently, and how this influences policy decisions about how we stop it.

In the short run, price inflation tends to affect low-income families more than high-income families. This is because lower-income households consume goods that are more sensitive to inflation. The effect is not large, and the arrival of wage inflation effectively erases income differences in its effect. However, over the long term, inflation is far more damaging to higher-income households, because high-income families hold more savings.

Inflation affects both goods and services, and the price of borrowing money. However, a large share of household savings is held in fixed interest rate accounts. Like George Bailey explained in “It’s A Wonderful Life,” the money held in his savings and loan wasn’t in the bank safe, it was in the mortgages and small business loans around the city. That remains true today. Likewise, most savers have money in long-term fixed rate accounts such as municipal bonds.

Inflation rapidly degrades the value of the payout of fixed-rate mortgages and bonds. If it is bad enough, it can lead to insolvency of banks. Indeed, the 1987 Savings and Loan Crisis wasn’t about greed (a commodity in apparently constant supply), but was the hangover of 1970s and 1980s inflation. This makes arresting inflation a chief concern of the Federal Reserve.

Inflation does benefit borrowers of fixed-price assets. So, holders of fixed-rate student loans and mortgages find themselves benefitting from inflation as the real cost of that borrowing declines, while their wages grow. Of course, this makes long-term borrowing by anyone else more expensive, so no one should welcome it.

We are early in an inflationary period, and it seems likely that higher interest rates and other Fed policies will eventually reduce inflation to the 2.0 to 2.5 percent target rate. How much rates must rise, and how fast they will take effect can be estimated from interest rate history, but how likely history will repeat itself remains an open question.