Inflation is growing at its fastest pace in 20 years.

The value of a typical worker's pay packet has been deteriorating since mid-2021.

How much should we be worrying? Will things get even worse?

It's a conundrum for the Reserve Bank, but it wants you to feel like it's got things under control.

Caught off guard

The recent surge in consumer inflation has caught the RBA by surprise.

We haven't seen inflation like this in the modern era.

Underlying inflation — which removes volatile price movements from the data to see the truer rate of inflation underneath — grew by 1.4 per cent in the March quarter.

It was the fastest quarterly growth in prices since the RBA began targeting inflation in 1993.

See the graph below.

The range of goods experiencing notable price increases has also increased in recent months.

In the March quarter, around 70 per cent of the goods in the consumer price index (CPI) "basket" had an annualised inflation rate above 2.5 per cent.

We haven't seen generalised price increases like that since before the global financial crisis.

See below.

So, not only are prices rising, but the price increases are spreading through the economy.

Here's where things currently stand (at the end of March):

• Fuel prices have jumped by 35 per cent in the past 12 months, which is the largest annual increase since 1990
• Building materials prices are 15.4 per cent higher than a year ago
• Consumer durables inflation is rising at its fastest pace in more than three decades (this category includes motor vehicles, household furniture and goods, and computers and televisions, among other things) 
• Grocery prices (excluding fruit and vegetables) rose 2.8 per cent in the quarter, which is the strongest quarterly increase since 1983
• Fruit and vegetable prices are 6.75 per cent higher than a year ago
• Rents rose by 0.6 per cent in the March quarter, which is the strongest quarterly increase since the September quarter of 2014
• Tertiary education prices increased by more than 5 per cent in the March quarter, driven by the federal government’s decision to increase the cost of some university courses

Has your weekly wage increased at similar rates?

I doubt it.

The real value of your wage (adjusted for inflation) has likely been deteriorating.

In fact, the RBA says real wages have been declining in Australia since mid-2021, and it's hurting poorer households the most.

"Cost-of-living pressures from rising food and fuel costs are likely to fall unevenly across households, as lower-income households spend a greater proportion of their income on food and fuel and have relatively limited buffers of savings to draw upon," the RBA said last week.

Which brings us to its decision to lift interest rates.

So, where to from here?

Last week, the RBA lifted the cash rate target from 0.1 per cent to 0.35 per cent.

It said it partly did so because interest rates couldn't stay at these emergency low levels forever. Rates have to start returning to more "normal" levels.

But it also lifted the cash rate target because it is concerned about people's expectations.

It doesn't want people to start expecting inflation to be higher in the future because then people may start behaving as though it will be higher.

What does that mean?

Well, if you think prices will keep rising quickly, you may become militant about demanding regular pay increases.

If you think the nominal value of any savings you have will be deteriorating more quickly, you may change your spending and saving behaviour. 

On the business side, if retailers and wholesalers expect prices to rise more quickly in coming years, how will that change their behaviour? 

What will it do to contracts in the building industry?

The list goes on.

That's why the RBA doesn't want people to think it's lost control of prices.

So, it's started lifting the cash rate target to signal to people that it's not going to let inflation run away.

Will it work?

Well, ignore the fact that economists say rising interest rates actually contribute to the rising level of prices.

And put aside the question, for today, of what rising rates could do to people's employment and wage prospects in the current environment.

Will the RBA's decision to begin lifting rates help assure people that the pace of inflation won't keep quickening in coming years?

Currently, the short-term inflation expectations of households, union officials, and market economists have already jumped higher.

The "short term" refers to where people think the rate of inflation will be in 12 months' time.

See below.

However, their long-term inflation expectations haven't increased by the same degree.

And from the RBA's perspective, that means there's still time to convince people that inflation won't get out of control.

See below. 

But how hard will it be to cool people's inflation expectations without hurting households?

Could there be better ways to dampen inflation without lifting interest rates? 

The optimistic route to lower inflation

Dean Baker, a senior economist at the Center for Economic and Policy Research in the United States, wrote about these issues recently.

He reflected on the fact that developed economies like the United States, the UK, and much of Europe were experiencing levels of inflation that were similar.

He said the global supply chain disruptions that led to the original jump in prices in the pandemic era lasted longer and were more far-reaching than he had expected, and that was partly due to successive waves of coronavirus washing across the world.

He said the other source of disruption was Russia's invasion of Ukraine, with its serious impact on food prices and oil and gas prices.

"The idea that inflation would spike under such circumstances should not be surprising," he said.

"The normal delivery of goods and services was disrupted by the pandemic."

But, when wondering how policymakers might bring inflation back down in the United States, he said there were two possible routes to take at the moment — one good, the other bad.

"The optimistic path for lowering inflation would be for an end to the supply chain issues that pushed inflation higher," he said.

"This means an end to the backlogs at ports, an end to the shortage of truckers, and an end to COVID-19-related shutdowns in China and other manufacturing locations.

"Also, the shift back to services will reduce the extent to which demand for goods is exceeding the economy’s ability to supply them.

"The story would be that when these disruptions are ended, or at least ameliorated, the prices of many items would stop rising and even come back down. This should not sound far-fetched."

The other possible route would be a bad story, he said.

"In this view, we are already seeing a wage-price spiral," he said of the US economy.

"High inflation is changing people's expectations, with workers now looking to get higher wage increases to compensate for the high inflation of the prior year.

"A round of wage increases that compensate for last year’s inflation will put more upward pressure on prices. This sequence continues, with inflation rates getting to ever more unacceptable levels."

He said in the 1970s, high inflation in the US was finally broken by the Federal Reserve's decision to jack up its overnight interest rate above 20 per cent.

That led to a steep recession in 1981-82, with the unemployment rate peaking above 11 per cent. It eventually brought inflation back down, but it caused enormous pain for millions of people.

"This point is important to keep in mind," he said.

"There is not a simple and painless way to bring down the inflation rate through rate hikes by the Fed."

"There is no simple way to resolve this problem," he concluded.

Can Australia achieve lower inflation in a painless way, or will that be impossible?

With two weeks to go until the federal election, the major parties haven't spent much time talking about it.