On Friday, the Labor Department revealed that the consumer price index (CPI) has climbed 6.8% over the past 12 months. This represents the fastest annual pace in almost 40 years. Inflation of this magnitude is eroding paychecks and undermining the real value of saving accounts. To combat inflation, a growing number of economists are calling for a pullback in fiscal and monetary stimulus.

The latest University of Michigan consumer confidence survey highlighted that consumer sentiment is at a 10-year low. 76% of respondents said that inflation was the most serious problem facing the nation.

Greg Ip wrote in the Wall Street Journal, “Over his first term in office, Jerome Powell became arguably the most dovish chairman in the Federal Reserve’s modern history, giving priority to full employment in an era in which inflation seemed extinct. In his second term, he may have to execute the reverse: giving priority to inflation at the risk of sacrificing jobs.” Doves prioritize keeping unemployment low over keeping inflation low, thus supporting low-interest rates and an expansionary monetary policy.

Katy Bostjancic, chief U.S. financial economist at Oxford Economics, said on Bloomberg Television, “This is a very difficult spot for them. Inflation is going to stay hot and sticky through the first quarter.”

Bloomberg reported average costs in almost all categories that comprise the CPI have increased — gasoline, shelter, food and vehicles.

• Gasoline climbed 6.1%.

• National median rent increased 11.4% since the beginning of the year.

• Food at home rose 6.4% from one year ago.

The data underscores a perfect storm of disrupted supply chains, a rebounding economy, robust consumer demand and labor constraints that in the aggregate have driven up prices. The lack of semiconductor chips and the breakdown in the supply chain have constrained supply. Consequently, firms can raise prices and workers can demand higher wages. The U.S. has more job openings now than in any time in history, and unemployment remains low at 4.2%.

In the early stages of inflation, the public can be fooled by what economists call the “money illusion.” The money illusion highlights that people tend to view their wealth in nominal dollar terms, ignoring their loss of buying power.

There is now, however, a distinct change in sentiment. In recent months, rising prices have angered the American public. To quote Abraham Lincoln, “You cannot fool all the people, all the time.”

A.W. Phillips developed an economic theory named the Phillips curve. Phillips observed that inflation is tied to economic growth. If we sustain a very high growth rate, then our inflation rate will also increase.

The pandemic and subsequent inflation have widened our wealth gap. While wages have risen substantially in recent months, they have not increased as fast as consumer prices. Inflation-adjusted hourly earnings fell 1.9% from a year earlier. By contrast people with assets have done well. According to Freddie Mac, home prices have increased 14% in 2021. The S&P 500 has risen 27% since the beginning of 2021. Net worth (assets minus liabilities) has increased to a record $144.7 trillion.

Both the federal government and the Federal Reserve need to recognize that inflation is undermining their recovery programs. If we sustain 7% inflation for 10 years, our buying power decreases 50% over the same period. Sustained higher prices are calamitous for people living off a fixed income.

William McChesney Martin, who served as Chairman of the Federal Reserve from 1951-1970, famously said that the job of the Federal Reserve was “to take away the punch bowl just as the party gets going.” Historically, raising interest rates when the economy is percolating has been the remedy for inflation. In the early 1980’s when America was laboring under double digit inflation, then Chairman of the Federal Reserve Paul Volcker raised overnight interest rates to above 20% to combat Stagflation.

Originally published in the Sarasota Herald-Tribune