Inflation May Have Already Peaked. The Fed Needs to Step Gingerly.

“Many people see gas prices several times a day,” said Yuriy Gorodnichenko, an economist at the University of California, Berkeley. “They are salient. They affect inflation expectations in a big way.”

But they are contributing to a sense of panic that, I think, is unwarranted, because inflation may have already peaked, as I will explain.

Reining in expectations.

When inflation expectations become “unanchored” — when they far exceed the 2 to 3 percent range that the Federal Reserve deems an appropriate inflation target — an economy is often seen to have entered dangerous territory. That may be happening among the general public.

People who run businesses are especially important because they set prices. They expect inflation to rise 5.6 percent over the next 12 months, a survey posted on Professor Gorodnichenko’s website found. “This is a very difficult problem for policymakers,” he said.

The Federal Reserve has little choice under these circumstances, given its mandate to keep inflation under control: It must tighten financial conditions, and expectations are high that it will do so at its March 15-16 meeting. Jerome Powell, the Fed chair, said in a news conference last month that the Fed would proceed with “humility,” and respond nimbly to the data before it. Financial markets project that the benchmark Fed funds rate will rise above 1.50 percent by December, from its current near-zero level.

The Fed has an enormous immediate impact on financial markets: Anticipation of Fed tightening has already unnerved many stock and bond investors, and further bouts of higher volatility can be expected.

But the Fed’s ability to constrain inflation over the short term is limited, at best. Nothing it can do is likely to have an immediate effect on the cost of gasoline or the thousands of items whose prices have risen largely because of supply-chain bottlenecks.

Alberto Cavallo, a Harvard economist who has studied inflation using vast quantities of high-frequency online price data, told me that he expected the inflationary impact of the pandemic to linger for months.

Initially, he said, the C.P.I. understated the pandemic’s inflationary impact when people could not easily find substitutes for products that became scarce or disappeared. Many retailers at first refrained from raising prices out of a sense of fairness and propriety but as the pandemic continued, they did so for those items that they could still obtain and sell.

As a category, for example, transportation — including cars whose prices have jumped because of shortages of semiconductors and other critical parts — has increased sharply. And, he said, the C.P.I. may now be overstating overall inflation, much as it understated it earlier.

But, he said, he is finding that even when supply issues ease, retailers still raise prices for several months. Furthermore, thanks in part to fiscal and monetary stimulus, and to recovery from the pandemic, demand is increasing, also leading to higher prices.

“We’re not seeing much of a slowdown in inflation yet,” he said. “The Fed definitely has to act.”

Reasons to calm down.

No matter how you measure it, the rate of inflation today is much higher than it was before the start of the pandemic. And inflation has been elevated too long for policymakers to be able to continue to describe the problem as “transitory,” as they did last year.

Words are important. Transitory was the wrong word.

But if you simply say the effects of the pandemic are continuing and many of them will abate on their own, I think you will be absolutely correct.

Exactly how much of the inflation surge is attributable to the pandemic and will be alleviated without intervention is impossible to say with accuracy. “Forecasting the future of inflation right now is hazardous,” said Michael Weber, an economist at the University of Chicago. “It’s just too complex.”

There are reasons to be more optimistic than most of the headlines would suggest, however.

Most basically, if you look at the monthly C.P.I. numbers — as well as those of other inflation measures — you will find that although inflation is high, it is not spiking.

Mark Zandi, chief economist at Moody’s Analytics, which conducts economic research and risk analysis, put it clearly in a conversation on Wednesday. “Inflation has already peaked,” he said. “It peaked in October.”

How is this possible?

A close look at the numbers shows that the annual C.P.I. inflation rate reflects the very low base levels of one year ago, when the pandemic had suppressed demand and prices were low. The month-to-month numbers support a different narrative.

Consider that monthly C.P.I. rose:

• 0.9 percent in October.

• 0.7 percent in November.

• 0.6 percent in December.

• 0.6 percent in January.

It’s true that this has been the worst year for inflation in more than 40 years, but we’ve known that for months. What these numbers show is that although inflation is high, it has also been fairly stable on a month-to-month basis. Mr. Zandi, who says he takes “a sanguine view,” expects that the annual C.P.I. numbers will start to decline in several months, whatever the Fed does. And much as annual corporate earnings look better when compared with low numbers a year earlier, the decline in the annual C.P.I. rate will look even better in comparison with the steep readings of the past year. That’s just math.

The Fed does need to raise rates considerably over a few years and reduce its swollen balance sheet, he said, but that can be good news because it means extraordinary measures are no longer needed and it’s time to “normalize.”

In short, it might be helpful to reframe the C.P.I. news.

Newspapers could quite accurately have run this much duller headline: Inflation Remained Stable, Well Below Its October Peak.

Not a wage-price spiral.

When inflation becomes deeply worrisome, it is typically because a “wage-price spiral” has set in, with workers responding to price increases with demands for even greater wage increases, and so on.

But that hasn’t happened so far.

Yes, after years of rising corporate profits and meager raises, many workers have greater leverage these days, and are demanding more pay. Why shouldn’t they?

Labor shortages induced by the pandemic appear to have accelerated corporate investment in capital equipment like computers and software that are increasing productivity, Ian Shepherdson, chief economist of Pantheon Macroeconomics, a research firm, said Wednesday in an online talk.

That could produce a happy confluence of events: rising wages, offset by rising productivity, while inflation ebbs, thanks to the Fed and to the easing of pandemic effects.

Let’s hope so.

The alternative, a true wage-price spiral fueling runaway inflation, is something the United States hasn’t seen since Paul A. Volcker was Fed chairman from 1979 until 1987. It took brutally high interest rates, soaring unemployment and two recessions to wring high inflation out of the national psyche.

In a new paper, Ray Fair, the Yale economist, used his longstanding econometric model to test the effects of Fed rate increases. In a telephone interview, he said his conclusion was this: “If the Fed had to take down, say, 5 percentage points of inflation and try do it all in one year, it would be far more disruptive than most people understand.”

That’s all the more reason for the Fed to rein in inflation expectations through clear communications about its intentions, while ever so gently raising interest rates. Mr. Zandi said he believed it was possible to have a soft landing, preserving the economic recovery while the inflation narrative shifts.

“Inflation is high but it’s going down.” With a little bit of luck, that mantra can prevail a few months from now.

The alternatives are too bleak to contemplate.