When the word “inflation” appears in the news, it’s often mentioned in negative terms. But Farmer School associate professor of economics Jonathan Wolff says inflation shouldn’t be a bad word. “There is this perceived notion that inflation is everywhere and always bad.  Low, stable, predicted inflation is not a bad thing. What's bad is high, stubbornly persistent inflation. What we have right now is the market slowly working to clear large imbalances of low supply and unnaturally high demand."

That’s the challenge that the American economy has been facing for more than a year now, as the nation moved back into some semblance of pre-pandemic normalcy. Consumers bought things, went on vacations, and used more fuel. And prices rose. Inflation climbed from 1.2% in early 2021 to more than 9% in June 2022.

How are the inflation numbers as 2023 begins? It depends on what numbers you look at, FSB assistant professor of economics David Lindequist said. “The big picture is that inflation has come down, but what's confusing about inflation numbers these days is that you hear people referring to different reference points,” he said. “Inflation is still high, and well above the Fed’s target of 2%, if you compare prices today to prices one year ago. It is significantly less high if you compare prices today to prices three months ago since many prices have been steady or even decreasing over the last few months.”

The impacts of inflation aren’t felt equally, assistant professor of economics Nam Vu pointed out. “The impact of inflation is actually not homogeneous across different level of income. For example, if you have either low income or high income, you actually see a growth in your real wage, as in the wage that is adjusted for inflation. But if you look at the middle class, that is where we have issues,” he said.

A driving force for inflation back in 2021 was the ongoing global supply chain crisis, which still isn’t quite resolved in some sectors. But a new factor has taken hold over the last several months – the labor market. “We have a very tight labor market – there are more jobs than job seekers right now.  Employers have to pay more for the workers, and that can drive up the cost for labor, which is reflected in the increase in the price of services,” Vu said.

“For every unemployed person, there are 1.7 job openings out there. Even if everybody looking for one now had a job, there would still be job openings. The hope is that maybe instead of having people fired, you just close these job openings and that's the soft landing, where unemployment really doesn’t increase much, but the labor market is cooling off because we get rid of this excess of job openings,” Lindequist said.

But the tech sector has been shedding tens of thousands of workers in the last few months, something Wolff said isn’t surprising. “Tech in particular saw a ton of hiring during the pandemic, and a lot of these companies are getting their payrolls back to the size that they were before the pandemic,” he said. “Labor's becoming more expensive as people are demanding higher wages and they're moving around between industries.”   

And, Wolff said, companies are preparing themselves in case recession is on the horizon. “There's a lot of uncertainty about the direction that the economy's going right now. Significant percentages of CEOs are predicting recession right now,” he said. “We saw that businesses that entered the pandemic with extra cash on hand, with less overhead, came out much stronger. So businesses are trying to enter this possible next recession in a healthy way so that they can survive and grow.”

“The recession is a mild concern, but is not a severe concern,” Vu said. “There's still room to put at least pressure on inflation.”

That pressure, if it comes, will at least partly come from interest rates set by the Federal Reserve. What will happen at the next meeting of the Board of Governors in mid-February could mean the difference between recovery and recession.

“That will be very tricky because currently the labor market is still going very strong and whatever inflation is left is now mostly in services. And that's mostly driven by wages going up all over the place because the labor market is going so well,” Lindequist said. “At some point, if the Fed still wants to keep on reducing inflation, it may have to cool down the labor market, which people don't like for understandable reasons. But it may be what’s needed to bring inflation back to the Fed’s target of 2%.”

“The Fed is doing what they need to do. They are slowing demand,” Wolff said. “They're looking for a soft landing. And so what they're looking to do is guide the economy in by slowing demand just enough to tame inflation, but not so much that it leads to rapid increases in unemployment and economic decline.”

“I would imagine they would at least keep the interest rate high for right now, and if they increase the interest rates, they would increase them very slowly,” Vu said. “If they keep increasing, 50 basis points or a full percent, that'll completely kill the economy, kill the momentum, which is something that they don't really want to do because they would end up with in a situation that you have high inflation at the same time you would have low economic growth.”

“So expect this to play out over several months. We've been saying that since the beginning that this is going to be a long-term battle,” Wolff said. “That looks like another six to nine months of really clear communication on the Fed’s part that we're going to stay the course until inflation begins to approach more normal levels.”

Previous: Ask The Experts: Inflation