Era of uncomfortable inflation changing economy

Biggest question is how families and businesses react in trying times

One of the biggest problems with inflation right now is what’s happening in Americans’ minds as their expectations shift about how much goods will cost going forward.

News this week that U.S. inflation is running at a 13-year high of 5.4 percent confirmed what many Americans know as they juggle their own budgets: food, energy and shelter costs are all rising rapidly, adding to the strain from high costs of hard-to-find goods such as cars, dishwashers and washing machines.

While policymakers debate how long higher prices will last the real question is how American families and businesses are going to react to this new era of uncomfortable inflation.

Atlanta Federal Reserve President Raphael Bostic said his main concern is that the longer inflation remains high, the more likely it is that businesses and workers believe it will not come down. Then they begin to alter their habits.

Workers are demanding pay increases since they can see their wages aren’t buying as much with so many everyday necessities costing more, including rent. That leads companies to hike prices more, and then workers turn around and demand another pay raise. Economists call this phenomenon a “wage-price spiral.” It often leads to sustained high inflation that forces the Fed to stop it. Alternatively, consumers could pull back on spending as they fear high prices, which could lead to a recession.

Already, there are signs of a psychological shift. Numerous polls and consumer sentiment surveys show inflation has become a top concern for many Americans.

“During the past five months consumers have become much more concerned about rising inflation and slower wage growth and their negative impact on their living standards,” the University of Michigan Consumer Survey reported in September. This week, the New York Fed’s consumer survey showed Americans predict 4 percent inflation for the next year and 3.4 percent for the next three years — the highest levels since the survey began in 2013.

Businesses large and small are now openly predicting higher inflation will stick around, signaling new assumptions about the future.

There are also signs of wageprice spirals building, especially in the restaurant sector.

Across the country, restaurant prices are up nearly 5 percent over a year ago, the Labor Department reported Wednesday. Rising food and housing costs accounted for more than half of the inflation jump in the past year, a sign that supply chain glitches and worker shortages are spreading with little sign of easing soon.

Rising food, gas and rent costs hit the budgets of low and middle-income Americans hard. While wages have been rising at the fastest pace in decades, the gains have been eaten up entirely by rising costs, Labor Department data show. This prompts workers to ask for more pay.

Some economists see these widespread price increases as a sign that the psychological dynamics are shifting. But other economists say what is occurring is still related to the pandemic and the pressures will subside in the coming months.

Across the country, families and business owners have adjusted their thinking for an extended period of uncomfortable inflation.

“We’re going to see inflation that is meaningfully higher than the Fed wants through 2022 and maybe into 2023,” said Adam Posen, president of the Peterson Institute for International Economics. “All it takes is a little bit of wage pressure to get you inflation that lasts longer than six to nine months.”

It’s hard to reverse psychological and behavioral shifts.