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The inflation bugaboo is back.

The Consumer Price Index — a key measure of inflation — took many investors and economists by surprise when it shot upward 5.4 percent year over year in June. That marks the fastest gain since 2008 and the third consecutive monthly increase in prices. The news has fueled fears that the U.S. economy is overheating and had both the Biden administration and the Federal Reserve racing to reassure lawmakers and the public that the spike would prove temporary.

Not everyone is convinced, however. Some macroeconomists worry that rising prices are here to stay and could lead us back to 1970s-era inflation. That’s when a seemingly intractable cycle of price and wage increases hobbled the U.S. economy for nearly a decade and broke only after the Fed took drastic and painful steps.

The big question now is, what is happening with inflation this time?

Monika Piazzesi, the Joan Kenney Professor of Economics in the ��ɫ��Ӱ School of Humanities and Sciences, is a renowned macroeconomist and senior fellow at the ��ɫ��Ӱ Institute for Economic Policy Research (SIEPR). Her research and forecasting expertise have helped shape monetary and financial market policies for two decades. Piazzesi recently spoke at a meeting with SIEPR supporters and weighed in on the hot-button topic. Here are a few excerpts that give her take on the pricing pop and potential warning signs.

Inflation risks come and go. Should we be worried?

First, keep in mind that we don’t really need to worry about little blips in inflation. But what would be troubling is going back to the Great Inflation of the 1970s.

There’s reason to be happy about having some inflation. It feels like yesterday that we were worried about low inflation, which over the last decade has been below the 2 percent target set by the Fed. The Fed couldn’t get inflation up no matter what it did. We worried that we would become like Japan, which experienced chronic deflation for nearly two decades that kept wages and corporate investment low. But since inflation has gone up, we no longer have to worry about that.

It’s also important to remember that high-inflation episodes are not that unusual. If you look at July 2008, the rate was above 5 percent. In September 2005, it was close to 5 percent. In 1990, it was above 5 percent. So, it’s not unusual to have inflation around or higher than 5 percent. In fact, sometimes it has to be higher than 2 percent for it to average out to 2 percent.

So, there’s reason to think the recent increases in inflation are healthy for the economy. Then what’s the cause for concern here?

There is one big red flag in the top line numbers. Usually, when you have a temporary blip in overall inflation, core inflation — which is consumer prices minus food and energy, which tend to fluctuate wildly — doesn’t also come up. But the June Consumer Price Index number for core inflation jumped 4.5 percent. That’s a large, potentially worrisome increase that’s worth keeping an eye on.

You’ve done a lot of . What are signs this could just be a temporary uptick?

It’s important to remember that forecasting inflation is really hard. Nobody has a crystal ball. The $1 million question right now is, will the soaring inflation we saw in June be a transitory, or temporary, phenomenon or will it persist? There are economic reasons why either may be happening.

One reason why this may be transitory is that inflation expectations have already been set. The Fed has been very successful at convincing the public that it will do everything to target 2 percent inflation. The Fed recently did a policy review, which concluded that some inflation would be good so that times with below 2 percent inflation are balanced out by times with above 2 percent inflation. Another reason this may be temporary are supply and manufacturing bottlenecks. These bottlenecks manifest themselves, for example, in marine traffic congestion – the port of Oakland and other major ports around the world are experiencing record volume and delays in processing ships.  There’s also pent-up consumer demand to spend, now that economies are reopening. Harvard economist Jason Furman estimates there is $2.2 trillion in excess savings for people to spend.

What also gives me a lot of peace of mind is that investors don’t appear to be very worried about inflation. The strongest signal of that is coming from the really low rates on 10-year Treasury bonds and low 10-year breakeven inflation numbers, measured as the difference between the 10-year nominal Treasury rate and the 10-year TIPS rate, or Treasury Inflation-Protected Securities rate. People are putting their money where their opinion is, and the Treasury market is basically telling us that there’s a chance inflation will persist, but the chance is low.

Let’s talk about risks of high inflation over the long haul.

I am concerned that high inflation rates may persist, and it mainly has to do with the growing Fed balance sheet and the explosive growth of what economists call “inside money.”

I’ll talk first about the Fed balance sheet, which is basically total assets in the Federal Reserve system. Total assets have to be total liabilities, so what’s the liability of the Federal Reserve system? It’s paper currency and it’s also reserves. Reserves are the accounts that commercial banks have with the Federal Reserve system.

Before the 2008-09 global financial crisis, reserves were scarce — well below $1 trillion. Then when the financial crisis hit, the Fed added $3.5 trillion of extra reserves as part of quantitative easing. This allowed the Fed to buy all sorts of assets from commercial banks and to pay for these assets using reserves. The idea was to encourage lending and investing to prevent a total collapse of the U.S. financial system. As we all know, it worked.

This $3.5 trillion created a very large balance sheet that everyone expected the Fed to unwind and, in fact, there was an attempt to do that in the years before the pandemic hit. But when the COVID-19 outbreak happened, and fears of a looming economic catastrophe were high, the Fed added another $3.5 trillion in reserves to support the U.S. financial system. Now, the Fed’s balance sheet has $8 trillion in liabilities.

How does “inside money” come into play?

A key question now is: Do these Federal Reserve liabilities cause inflation? Economic theory holds that the answer is yes, but only if there is also growth in “inside money,” which measures all bank deposits, money market funds, and other liquid accounts that we use to make payments. If we have more money to spend, but the quantity of goods we buy doesn’t change, prices go up, and we get inflation.

The connection between the growth of inside money and inflation is strong. During the global financial crisis, we had a huge increase in Fed reserves and a small increase in inside money, and therefore very little inflation. Now, during the pandemic, both the growth rates of reserves and inside money have been humongous — just like they were in the 1970s. That’s cause for concern.