How inflation affects our economy, and what can be done about it : Planet Money Two stories about the effects of inflation on the economy. We meet a gig worker who's seen an increase in wages, but because of inflation, how much of that increase in earnings is an illusion? Then, we break down how the Federal Reserve is planning to fight inflation. | Subscribe to our weekly newsletter here.

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SYLVIE DOUGLIS, BYLINE: This is PLANET MONEY from NPR.

(SOUNDBITE OF COIN SPINNING)

STACEY VANEK SMITH, HOST:

Hey, everyone, I'm Stacey Vanek Smith. I host The Indicator, PLANET MONEY's daily podcast, and I am in your PLANET MONEY feed today to bring you two recent episodes about a big problem that we have been seeing in the economy right now - inflation. So inflation basically just means prices rising. And in the past year, we've seen prices on a whole bunch of things rise, in some cases, really fast. Overall, prices have grown about 7 1/2%. That's according to the Consumer Price Index, which tracks these things. So today on the show, two stories about the effects of inflation and about what can be done about it.

(SOUNDBITE OF DROP ELECTRIC SONG, "WAKING UP TO THE FIRE")

VANEK SMITH: Kristal Moore lives in Hendersonville, N.C. She's 52 years old, and she works a lot. She has a lot of jobs.

JULIA RITCHEY, BYLINE: Yeah, Kristal is a gig worker. And over the last couple of years, she's driven for ride share companies, also delivering meals and groceries for Instacart and Uber Eats.

VANEK SMITH: And producer Julia Ritchey, hello.

RITCHEY: Hi.

VANEK SMITH: (Laughter) You sat down (laughter) with Kristal Moore in Hendersonville.

RITCHEY: Yeah. We locals call it Hendo, just FYI (laughter).

VANEK SMITH: Hendo. OK. OK, it's shorter, I like that. It's fast.

RITCHEY: Yes. Yes, that's just the parlance around here. So I talked with Kristal on the porch outside of her apartment. She has these, like, sparkling brown eyes and this really infectious smile. And, you know, she's, like, one of those people, Stacey, who calls everybody honey, including this, like, delivery guy (laughter) who was looking a little bit lost outside.

KRISTAL MOORE: What's the matter, honey?

UNIDENTIFIED PERSON #1: Deliver a package?

MOORE: For Rebecca?

RITCHEY: Yeah.

MOORE: Yeah, honey.

UNIDENTIFIED PERSON #1: And she's having a wedding dress delivered, and just...

MOORE: We're busy around here today (laughter).

RITCHEY: I know.

Kristal loves chatting with people. She loves feeling helpful, and that's kind of part of why food delivery and ride share really suited her during the pandemic.

VANEK SMITH: Yeah, I mean, for the past couple of years, where a lot of us were inside almost all the time, Kristal was outside almost all the time, driving all over Hendo in her 2010 black Honda Civic.

MOORE: Which is very good on gas.

VANEK SMITH: And as the economy has been heating up. Kristal says her services are more and more in demand, and her pay has gone up as a result of that.

MOORE: When I started, the income was very profitable. People are, for the most part, very generous.

RITCHEY: So lately, Kristal has been getting slightly higher fees for each delivery, and she says people have been really great about tipping more, so she's been bringing in more money.

VANEK SMITH: At least she thought she was; this is where things get kind of weird. So Kristal is getting more and more money for each delivery. But then it was just kind of vanishing like it wasn't real.

MOORE: The profit is lower right now.

VANEK SMITH: The profit is lower. In other words, the extra money Kristal was taking home was somehow not showing up in her savings account.

So wages are rising all over the country right now, but prices are rising, too. In fact, they're up more than 7 1/2% over last year, which brings us to this question - have Americans gotten a real raise, or is it just an illusion?

(SOUNDBITE OF LAURENT DURY'S "NATURAL TIME CYCLES")

RITCHEY: Kristal Moore was very excited when she started working from her car in the early days of the pandemic, delivering food and driving people around. It was the perfect fit for her, to be honest. Her work was in great demand, and she liked feeling like she was helping people. She says, actually, a lot of the grocery deliveries that she made were for older people.

MOORE: You know, I love doing that because they can't. They're either worried to go out with the COVID, or they're just not able to drive anymore for themselves.

VANEK SMITH: And the money was good. Including tips, Kristal would take home around $20 for each delivery.

MOORE: And, of course, that sounds good until you factor in the gas. Prices have gone up on just about everything, food, gas, of course,

RITCHEY: And those rising prices started taking bigger and bigger bites out of Kristal's earnings and outpacing the rise in tips and pay she was getting, and she realized she had less money.

MOORE: I am still able to make it, so to speak, and pay my bills.

RITCHEY: Yeah.

MOORE: But it's a little more of a struggle right now.

RITCHEY: Kristal is experiencing something that millions of workers are going through all over the country. Pay is going up, people are getting raises, getting new jobs with higher pay, but that higher pay is not translating into actual wealth. It's the money illusion.

VANEK SMITH: The money illusion - so this is a term coined by economist Irving Fisher in the 1920s, and it has to do with the difference between so-called nominal wages and real wages.

MICHELLE HOLDER: Nominal wages, which are, you know, wages that the everyday Joe and Joanna gets for their work.

RITCHEY: Michelle Holder is an economist and the CEO of the Washington Center for Equitable Growth. So nominal is the actual dollar amount, the numbers you see on your paycheck. As people, we tend to respond mostly to this, to the number on our paychecks. And in nominal terms, Kristal was getting more money from her deliveries, but she wasn't feeling a lot richer.

VANEK SMITH: And the reason for that was because even though Kristal's nominal pay was rising, her real pay was not.

HOLDER: If we look at what economists call real wages, which are adjusted to reflect the true buying power of that money in...

RITCHEY: Buying power. Essentially, adjusted for inflation. Michelle points out that for workers in hospitality, wages are up more than 10% over last year. Some workplaces are reporting wages up by more than 15% or 20% or bonuses of thousands of dollars.

VANEK SMITH: Yeah. So even though inflation is high, I mean, like we said, prices are up more than 7 1/2% last year, wages in some sectors have risen faster than that. So it would seem that a lot of workers in the U.S. have gotten a raise.

RITCHEY: But that depends on a lot of factors, like where you live, what you do and what your personal expenses are.

VANEK SMITH: Yeah, I mean, take Kristal Moore. She has to buy gas for her work, and gas prices are up a lot more than 7.5%. They're up more like 40%.

MOORE: Got all my envelopes.

RITCHEY: All right. You do have a big stack of envelopes.

MOORE: Oh, yeah. I keep track of everything. I have to.

RITCHEY: That's great.

MOORE: So even last month, it was just a lot cheaper. I remember.

RITCHEY: Kristal always gets her gas at the same place. She has, you know, like, one of those little loyalty cards.

MOORE: So at Apple Valley Quality Plus in Hendersonville on Chimney Rock Road, date was September 23 of this year, it was $22.47 to fill up my tank.

RITCHEY: Twenty-two forty-seven in September. And less than a month later...

MOORE: October 19 of this year. And it was $31.29 to fill up my tank.

RITCHEY: That's...

MOORE: Quite an increase.

RITCHEY: Does that hit you kind of like, ugh?

MOORE: Oh, yes.

VANEK SMITH: For Kristal, gas prices have risen by about a third in less than a month.

RITCHEY: Kristal estimates she earns somewhere around $30,000 a year, Stacey, but that money is buying less and less gas, and less food and less clothing than it used to, because prices are up so much.

MOORE: Yeah, it's actually - it's horrible. And that's why I haven't been - I actually haven't been driving as much, because I almost feel like it's cheaper for me to stay at home.

RITCHEY: You have - you're, like, balancing this equation in your head, where it's like...

MOORE: Yes.

RITCHEY: ...I can make this much money if I go do this delivery, but then I'm putting this many miles on my car, which is wear and tear. Plus, I'm going to eat up this much fuel.

MOORE: Exactly.

VANEK SMITH: And it's like this for a lot of workers across the country. That's according to economist Michelle Holder. She says the data shows that U.S. workers have gotten a raise pretty much across the board, but in real terms, a lot of people have actually seen a decrease in pay or, at best, they've gotten a very tiny raise.

HOLDER: And so while I suspect and while the evidence suggests that workers overall in the U.S. economy have enjoyed some increase in real wages, that increase is really modest, probably less than 1%. Workers are not experiencing some humongous jump in their real wages by any stretch of the imagination.

VANEK SMITH: Yeah, I mean, right now there are a lot of forces that are disrupting our economy, and a lot of them are hopefully temporary. And so when the dust settles on all of this, we will know if our raises are real or if they're an illusion.

RITCHEY: For her part, Kristal is pretty done with all the volatility and the money illusions of gig work. She's applying to some other jobs that have a little more stability and hopefully require a lot less gas.

(SOUNDBITE OF ALEXANDER HITCHENS' "SNEAKY LOVE")

VANEK SMITH: Rising costs on basics like gas and food are eating into our paychecks. So what can be done to curb inflation? That's coming up after the break.

(SOUNDBITE OF ALEXANDER HITCHENS' "SNEAKY LOVE")

VANEK SMITH: Our second story about inflation comes from my PLANET MONEY Indicator colleagues, Adrian Ma and Darian Woods. They take a look at the fundamentals of inflation and how the Federal Reserve's biggest weapon against inflation actually works.

ADRIAN MA, BYLINE: The other day, we hit the streets of Manhattan to ask about price inflation.

DARIAN WOODS, BYLINE: Say, have you noticed prices rising?

UNIDENTIFIED PERSON #2: Yes, absolutely.

UNIDENTIFIED PERSON #3: Yes, I have.

UNIDENTIFIED PERSON #4: Yes.

UNIDENTIFIED PERSON #5: Definitely, yeah (laughter).

WOODS: And yeah, look, life (laughter) in New York has always been expensive, but across the U.S., the price of airline tickets, gas, housing, food - these things are all going up.

UNIDENTIFIED PERSON #2: We can't go grocery shopping without having a list, and we can't venture far from that list.

WOODS: The latest numbers on the cost of living showed that the inflation rate shot up to 7.5%, and that's the highest in 40 years, which has got people worried because in healthy economic times, inflation is pretty low - like, around 2%.

MA: And, you know, the government agency charged with keeping prices stable is the central bank, the Federal Reserve. And the Fed has one big tool for controlling inflation - interest rates.

WOODS: Interest rates are likely to go up this year. So what do you think will happen to price inflation overall when that happens?

UNIDENTIFIED PERSON #5: Oh, geez.

UNIDENTIFIED PERSON #3: I don't think it'll have that much of an effect.

UNIDENTIFIED PERSON #4: I honestly do not know.

UNIDENTIFIED PERSON #2: You're asking literally the least informed person, ever (laughter).

WOODS: (Laughter) I love an honest answer.

MA: I mean, probably for a good reason, most people do not spend as much time as we do thinking about the relationship between interest rates and inflation. And as it turns out, 4 out of 5 Americans don't necessarily know the connection between the two. That, at least, is according to a recent survey conducted by YouGov and The Economist newspaper.

WOODS: But soon, interest rates are likely to go higher. So we thought it was a good time for an explainer. To slow down inflation, the Federal Reserve has hinted that it is likely to start raising interest rates next month. And to explain how this all works, how raising interest rates decreases inflation, we called Martha Olney. Martha Olney is a teaching professor of economics at UC Berkeley.

MARTHA OLNEY: All right. Well, I'm glad you called me. I'm very happy to talk to you.

MA: Martha says that controlling inflation is really up to the Federal Reserve.

OLNEY: The Federal Reserve is really the only agency that we have that has any tool whatsoever that might help with inflation.

MA: So the Fed's big tool is interest rates. And it starts with the Fed targeting these baseline interest rates, which you can basically think about as the cheapest rate you can get to borrow money. And then banks, which are big lenders - they see that rate, and they say, OK, cool, that is our baseline. And then they use that rate to set the interest rate for all kinds of other credit products - right? - especially short-term loans, whether it's for credit cards or business loans or car loans. And this is how the Fed's interest rate ricochets through the entire economy.

WOODS: And so to understand what might happen later this year, let's talk about where we are now. We're at these really historically low interest rates, close to zero. And that's a decision that the Fed made at the start of the pandemic to help businesses borrow more cheaply and to hire more workers. And this worked, but it also contributed to inflation, as all that money bounces around the economy and businesses can't produce enough to keep up.

MA: And so what has the Fed done in the past to fight inflation? Raise interest rates. Pull back all that cheap money. And Martha says the way this helps reduce inflation is sort of indirect.

OLNEY: We expect that as a result of interest rates being increased, that there'll be a decrease in spending. It's unlikely to affect what you spend at the grocery store, but it's more likely to affect whether or not you buy a car, if you're borrowing to buy the car.

WOODS: But maybe even bigger than its effect on, you know, how everyday people spend is the effect that it'll have reducing business spending.

OLNEY: How much the businesses are spending on equipment and construction and these sorts of things. So you want to think about what are the loan-financed or the debt-financed activities, and those are the activities for which interest rates actually matter.

WOODS: Martha says these higher interest rates are meant to slow down the economy.

OLNEY: Fewer tractors need to be produced. Less equipment for businesses need to be produced. Less construction will take place. The next step in this story is that that's going to lead to layoffs, that that's going to lead to people losing their jobs.

MA: It could also mean that businesses that would be hiring decide not to.

OLNEY: So when we're looking at the monthly report of employment, we may not see an actual decrease in employment; we may see that employment doesn't increase as fast as we thought it was going to. The weakening of the labor market takes pressure off of wages, and thus slowing of the increase of wages would allow companies to not increase their prices quite as rapidly.

MA: OK, so you got that? The Fed reduces inflation by raising interest rates - basically, by making the cost of borrowing higher, which leads to less spending in the economy, businesses don't expand or hire as much, wages don't grow as fast. And all this economic pain is aimed at reducing pressure on businesses to raise prices.

WOODS: It seems like all pretty negative news.

OLNEY: It does seem like very negative news. And in fact, when you look historically at the times when the Federal Reserve has increased interest rates in order to beat back inflation - so particularly you want to look at the experience in the early 1980s when the Fed increased interest rates to beat back inflation - how did they do it? They did it by generating recessions.

MA: So the '80s approach was basically taking the economy from the frying pan to the fire. But there might be a path that is less dramatic, you know, a Goldilocks zone in the middle.

WOODS: And that's exactly what the Fed is trying to do right now. It's hoping that it can just slowly raise interest rates at just the right time, at just the right amount. Policymakers at the Fed want prices to stop rising so much, but they also want to avoid sending the economy into a tailspin.

OLNEY: Think about a car on the freeway, and the car is going 80 miles an hour. You could take your foot off the gas, bring it down to, like, 65, 60 miles an hour. You're not going to slam the brakes on and come to a screeching halt in the middle of the freeway. And the Fed is essentially trying to do the same thing with the economy.

MA: One way the Fed can ease inflation pressures without tipping the economy into a recession is to build up its reputation as an inflation fighter. That way, we the public start to trust the Fed will bring inflation down.

WOODS: This is called inflation expectations. These are public expectations of what inflation's going to be. And the reason why these are so important is that if you believe that inflation is going to be, say, 5% next year, you're going to ask for at least a 5% pay raise just to stay even. And that means that businesses will have to raise their prices by around 5% to recoup costs, and that can cause an inflationary spiral.

OLNEY: You ask your average Joseph or Joanne, Joe on the street, hey, what do you think the inflation rate is going to be next year? You want their answer to stay in the range of 2 to 2.5%. If the average answer starts ratcheting up - so on average, people are starting to say 4, 5, 6% - if that happens for too long, that sense of what prices are going to do next year starts to feed into what's going to happen to wages. And once those wages start ratcheting up, that's when the Fed particularly gets concerned.

MA: OK. So if this all depends on what the average Joe or Joanne on the street thinks, well, we can actually ask them.

WOODS: So price rises around 7% this year. That's quite high. What do you think the number will be next year?

UNIDENTIFIED PERSON #6: I hope it goes down. Will it? No.

WOODS: Give me a number.

UNIDENTIFIED PERSON #6: It's going to go back up to maybe 5%, I think.

UNIDENTIFIED PERSON #7: The price will go to 4%, yeah.

WOODS: Four percent?

UNIDENTIFIED PERSON #7: Yeah.

UNIDENTIFIED PERSON #8: Five percent?

UNIDENTIFIED PERSON #9: It's going to be, like, five.

UNIDENTIFIED PERSON #10: I'd like to say five. I want to be an optimist (laughter).

UNIDENTIFIED PERSON #11: Three.

UNIDENTIFIED PERSON #12: Ten.

WOODS: Wow.

UNIDENTIFIED PERSON #12: (Laughter) Like, I don't know. I just noticed, like, you know, stuff is, like, a lot more expensive than, you know, it was last year. Like, things are just way different.

WOODS: So our straw poll on the street is actually close to official surveys. According to the latest Fed survey, on average Americans see inflation staying high, at about 6%, and that's a number that is likely to keep Fed officials awake at night because when it comes to inflationary spirals, the collective brainpower of all the people on the street is much more important than what any one Ph.D. economist thinks.

MA: Or what two podcast hosts think.

WOODS: Exactly (laughter).

(SOUNDBITE OF BENJAMIN TOBIAS KIESER, JOHN K. SANDS, MARC FERRARI AND TREVOR ROY LEWALLEN'S "NO FOMO")

VANEK SMITH: If you have questions about inflation, please ask us, we would love to hear them. You can email us at planetmoney@npr.org. And we are @planetmoney on all the socials. And The Indicator is on Twitter, too, @theindicator. Today's Indicator episodes were originally produced by Brittany Cronin and Viet Le, with help from Neil Tevault and Isaac Rodrigues. They were fact-checked by Corey Bridges and Taylor Washington, and they were edited by Kate Concannon. This PLANET MONEY episode was produced by Emma Peaslee and Willa Rubin. It was edited by Jess Jiang. Our executive producer is Alex Goldmark. I'm Stacey Vanek Smith. This is NPR. Thanks for listening.

(SOUNDBITE OF BENJAMIN TOBIAS KIESER, JOHN K. SANDS, MARC FERRARI AND TREVOR ROY LEWALLEN'S "NO FOMO")

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