The funny thing about the current inflation scare is…it all happened so abruptly.

As the first Covid wave ripped through the US last spring, more than 20 million Americans lost their jobs and the country entered its worst recession in history. With GDP tumbling 31.4% in Q2 2020, the last thing worrying economists was surging prices. After all, for a brief moment, oil prices had just plummeted below $0.

But it turns out the worst recession in US history was also the shortest—by far. Thanks to government stimulus to the tune of nearly $6 trillion, many Americans were able to weather the storm and, flush with cash but restricted to their homes, went full Extreme Makeover.

Consider this: Consumer spending on goods was nearly 26% higher in August 2021 than in January 2019.

Demand is just one element of the price equation

And while demand for goods skyrocketed, supply was not ready to meet it. For a number of reasons—frequent Covid lockdowns in Asia, widespread labor shortages, poor planning—producers were unable to make and ship enough goods to satisfy the ravenous appetites of consumers.

So given this severe demand–supply imbalance, prices started to climb, slowly at first in late 2020 but then really picking up steam as the ball dropped on 2021. The consumer price index, which monitors the prices of a basket of consumer goods, grew 1.7% annually in February but by May had jumped 5%.

The higher inflation readings in spring 2021 were attributed to a few items that had an outsized impact on rising prices. You might remember all the fuss about used cars, which accounted for more than one-third of the monthly price increases in June. This weird dynamic lent ammo to the officials, Fed Chair Jerome Powell included, who argued that inflation was “transitory” and likely to subside once a few pandemic wrinkles had been ironed out.

But Team Transitory is on the back foot right now. This fall, inflation has spread from used cars and energy to items across the economy, from rents to food to apparel. At the same time, wages are surging, which is great for workers but also contributes to inflation, as companies must raise prices on their products to offset higher labor costs.

In October, consumer prices rose at their fastest pace in 31 years, and economists are still debating when inflation will peak.

So that’s how we got here.

Not a dumb question at all. In fact, many economists have trouble explaining exactly why inflation is so harmful.

Let’s start here: Inflation is good, when it grows slowly. The Fed targets a 2% rate of inflation over the long run, allowing for a few temporary blips.

Moderate inflation is a sign of a healthy economy. When consumers expect prices to increase in the future, they want to buy goods now. Producers take this demand as a sign that they should make more goods, hire more labor, make more investments, etc., which generates a “virtuous” cycle of growth.

• And while inflation does mean higher prices for consumers, it also leads to higher salaries, blunting its effects on your wallet.
• Last quarter, wages jumped the most in 20 years of record-keeping.

Okay, so when is inflation bad?

When higher prices outstrip wage growth, that’s bad, obviously, because your standard of living falls. Inflation is especially harmful to folks whose income is more fixed—like many seniors.

Inflation, when left unchecked, can also escalate quickly. As we mentioned before, inflation messes with the human brain. As workers grow concerned about rising prices, they push for higher wages, which in turn raises costs for businesses, which forces them to hike prices, and…lather, rinse, repeat. This is called the “wage–price spiral,” and it led to consumer prices rising more than 14% annually in 1980.

Finally, higher inflation is bad because it typically doesn’t end well. In a bid to stop the spiraling inflation of the 1970s, then-Fed Chair Paul Volcker cranked up interest rates to slow down the economy, a necessary action that inevitably resulted in a punishing recession.

As we’ll discuss a little later, current Fed leaders have a tough task ahead of them in trying to rein in inflation without hitting the brakes on economic growth.

This chart from the White House shows the six major inflationary episodes following World War II, as measured by the consumer price index (CPI) and personal consumption expenditures (PCE), which is the Fed’s preferred inflation gauge. Let’s briefly explore each episode.

1946–1948: In the years following WWII, inflation jumped more than 20% due to the scrapping of wartime price controls, surging consumer demand, and supply shortages.

1950–1951: The Korean War spurred a rush for goods, while some production pivoted back to military material.

1969–1971: GDP growth averaged a whopping 4.8% during this period of economic expansion, which also resulted in higher inflation.

1973–1982: Two shocks to energy markets (an OPEC oil embargo and conflicts in the Middle East) led to the longest stretch of inflation in US history.

1989–1991: Another war in the Middle East, the Gulf War, caused gas prices to spike.

2008: Oil prices jumped to $140/barrel in July 2008, double what they had been a year earlier.

What can we learn? While each inflationary period has its own unique characteristics, White House economists argue that our current situation most closely parallels the post-WWII bump in prices, which resulted from pent-up consumer demand and supply chain disruptions, and not 1970s-style inflation, which stemmed from extraordinary shocks to energy markets.

With inflation at its highest level since 1990, pressure is mounting on the central bank to channel Mr. Freeze and cool down prices.

What would that look like? Winding down its pandemic-era stimulus measures more aggressively. The central bank has already started to taper the $120 billion/month in bond purchases it began last summer, but some economists, such as Harvard’s Jason Furman, think the Fed should speed up the wind-down in a bid to stop price growth in its tracks.

• Some Fed officials agree. St. Louis Fed President James Bullard said recently, “It makes sense to try to move a little bit more hawkishly here and try to manage the inflation risk.”

But it’s not that simple. Remember, the Fed changed its policy framework in 2020 that allows it to overshoot its 2% inflation target in the short term to achieve “maximum employment,” the idea that anyone who is willing and able to work has the opportunity to get a job.

And while the unemployment rate has dropped more quickly than expected (it’s down to 4.6% from a 14.7% peak in May 2020), the economy remains 5 million jobs short of its pre-pandemic levels.

So the Fed is in a really tricky position. It knows people are anxious about inflation, but also that the labor market is not fully healed. Reducing its bond purchases more aggressively, then immediately hiking interest rates afterward, could slow the economy before it’s totally recovered.

Plus, there are signs that the supply chain crunch is beginning to ease, which would help cool prices on its own.

Looking ahead…the Fed meets in December for the final time in 2021. The big thing to watch for is whether Powell decides to reduce those bond purchases more quickly in order to quell inflation fears.

A few reads that have nothing to do with inflation—a true “what else is brewing.”

• DAOs, a canon
• The new luxury vacation: being dumped in the middle of nowhere
• The big business of being a chess champion (Magnus Carlsen is a name to know)
• The world’s most evil company: a Reddit thread with plenty of options
• Is the future of the music industry on the blockchain?
• The Sidekick Holiday Gift Guide

The first ever Morning Brew Holiday Sale is happening now. For a limited time, get free shipping when you spend at least $75 and get a free Morning Brew backpack when you spend at least $100. Plus, check out our limited-edition holiday drops.

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The only trivia we could possibly do for an inflation newsletter is a game in the spirit of The Price Is Right. So, we went to Walmart.com to look up the prices of a few items. How close can you get without going over?

1. 12 pack of Gatorade Zero (variety pack)
2. Clorox disinfecting wipes, 75 count
3. Lego Star Wars Imperial Light Cruiser kit (1,336 pieces)
4. Xbox Series X video game console
5. Canon wired all-in-one color inkjet printer