Bad news on the inflation front: over the past 12 months, the Labor Department said that the U.S. Consumer Price Index (CPI) rose by 5 percent from a year earlier, the biggest increase since August 2008.

The Federal Reserve (Fed) uses a different index to measure inflation, the Personal Consumption Expenditure. This index, which ignores the often volatile categories of food and energy, jumped 3.8 percent in May from the year before, the largest increase for that reading since June 1992.

Last August, the Fed adopted a historic shift to interest rate policy that places more emphasis on boosting employment, allowing inflation to rise above their 2 percent target and keeping rates lower for a longer period. The Fed said it believed that this inflation target is most consistent over the long run with meeting its challenging goals of maximum employment and stable prices, often called the dual mandate.

Now, with inflation on the rise, the critical question is whether higher than expected price increases are just because of the economy reopening or if they’re being caused by something more persistent.

Government policymakers and economists argue that it’s the former.  They claim some of the surge can be explained by a low base — prices fell dramatically last spring as consumers spent less in the face of the pandemic.  Most Americans spent last May quarantined in their homes, rather than shopping or taking a holiday, so the price of goods and services were quite low.

The Fed argues that the recent increase in inflation has been fueled by an unusual combination of short-term supply bottlenecks and pent-up demand from consumers finally emerging from their homes. Demand is also being driven by Americans who are flush with cash after multiple stimulus checks.

That said, it may be that COVID’s impact on global supply chains and production will prove more durable than anticipated and render inflation less transitory than the Fed expects. For example, the Federal Reserve Bank of Atlanta’s sticky price index, a weighted basket of items that change price relatively slowly, increased 4.5 percent in May, the largest increase since April 2009.

Also, labor scarcity is reversing decades of wage stagnation. Thanks in part to some people choosing not to look for work after Congress’s extension of an extra $300 a week in unemployment benefits until September, demand for workers is outstripping the supply, enabling workers to secure higher wages. The Fed argues that the strong labor market prior to the pandemic did not trigger a significant rise in inflation.

Inflation, defined as a general rise in the level of prices, is insidious. It erodes purchasing power over time if wages don’t keep up.  Even at an annual inflation rate of 2 percent, the purchasing power of $10,000 put under your mattress today is about $8,200 in 10 years.

By allowing inflation to rise above 2 percent, the Fed wanted to avoid inflation’s evil twin: deflation, or a sustained decline in the general price level.

Why does the Fed want to avoid falling prices? For starters, if consumers come to expect prices to decline in the future, they may delay purchases for as long as possible. Consequently, sales volume fall, corporate profits decline, unemployment rises, and the economy grows more slowly, causing prices to decline further.

There is a trade-off between price stability and maximum employment, and each scenario has winners and losers.  The intellectual heavy hitters at the Fed will surely wait for additional data before deciding whether to sacrifice full employment on the altar of price stability.  Of course, they might also face political pressure not to raise interest rates because, in an era of soaring debt and deficits, higher rates would increase government costs.

Such are the consequences in the Fed’s high-stakes game of determining whether rising inflation is a passing phase or a more permanent problem.

Capital markets are signaling increasing concerns about inflation as the economy recovers from the great virus crisis. Many experts are concerned that further cost-of-living increases will result as consumer demand outstrips supply.

On the other hand, the Federal Reserve believes inflation pressures caused from a near-term imbalance between demand and supply is transitory. But history teaches that inflation fears must be addressed early to avoid serious economic pain.

As the economy re-opens, the danger is that the US will experience a classic case of too much money chasing too few goods. There has been rampant money printing, and money that has been sitting in people’s bank accounts can now finally be spent.

Supply has been restricted by furloughs, mask wearing, social distancing and other policies to contain the pandemic. The Fed’s position is that recent increases in the prices of food, construction materials, used cars and gasoline, along with scattered labor shortages and surging home prices, will quickly fade post-pandemic.

But the Fed flooding the economy with massive amounts of liquidity may set the stage for a possible surge in price levels, stoking inflation. These fears are grounded in the 1970s, when the US underwent a period of double-digit inflation that led to painful memories for Americans who experienced the so-called Great Inflation.

During that time, inflation soared from a negligible 1.6 percent in 1965 to 13.5 percent in 1980. Stable prices provide people with a sense of security. They are like safe streets and clean drinking water. During the Great Inflation, people couldn’t predict whether their wages would keep pace with large price increases that had become the norm.

Inflation was blamed on such factors as President Nixon suspending the convertibility of the dollar into gold, which caused the value of the dollar to drop and triggered higher import prices; two oil price shocks; the massive cost of the Vietnam War; monetary policy mistakes; and the breakup of the Beatles.

People began to expect continuous price increases, so they bought more goods. Increased demand pushed up prices, leading to demands for higher wages, which triggered even higher prices, leading to a continuing upward spiral.

For example, labor contracts increasingly included automatic cost-of-living clauses that contributed to the inflationary wage-price spiral, and the government began to peg some payments, such as Social Security, to the Consumer Price Index, the best-known gauge of inflation. While these practices may have helped workers and retirees cope with inflation, they also perpetuated it.

Government’s ever-rising need for revenue increased the federal budget deficit and led to more government borrowing, which in turn pushed up interest rates and further increased costs for businesses and consumers.  With energy costs and interest rates high, business investment languished and unemployment exceeded 10 percent.  The simultaneous inflation and recession that followed wrecked many businesses and hurt countless Americans.

The Fed took drastic steps in the late 1970s and early 1980s, tightening monetary policy under legendary Chairman Paul Volcker to promote price stability and combat the persistent surge in inflation. Consequently, the federal funds rate soared from 10 percent at the start of 1979 to 19 percent by the middle of 1981. The unemployment rate peaked at 10.8 percent in late 1982.

During this severe recession, thousands of businesses failed because they did not have access to capital, and credit-dependent sectors of the economy, such as home and car sales, suffered dramatically. Volcker’s tight money policy was a tough pill to swallow, but it eventually had the desired effect. By the mid-1980s, inflation dipped below 5 percent.

The history of the Great Inflation holds important lessons for the future. One is that rising prices should be nipped in the bud, because there is no quick and painless fix for rampant inflation. The longer you wait to deal with it, the harder it becomes.

As the economist and philosopher Friedrich Hayek put it, “Taming inflation is like catching a tiger by the tail.”