Things Cost How Much?
The pandemic-era brought a focus on inflation not seen since the 1980’s. In response to the pandemic, the federal government increased the cash supply by more than 25%. This was an effort to stimulate the economy when growth was rapidly slowing. This effort worked, but not without consequences. If the cash supply increases by 25%, people now have more cash to buy limited goods and services. The result is an increase in equilibrium prices, or inflation.
Recently, it was announced that inflation as measured by the consumer price index rose 3% on a year-over-year basis through June 2024. The Bureau of Labor Statistics (BLS) said this was a decline of 3.3% in May and down from a 9.1% pandemic-era peak.
When the average person hears this, their typical comment is, “How can things be down? Everything is more expensive, especially at the grocery store.”
Much like the field of finance, economists have their own confusing language. When an economist says, “Inflation was 3%, down from 3.3% and down from 9.1%,” it does not mean inflation dropped. Rather, they are referencing the rate of growth. In this case, inflation is still growing 3%, but not as fast as it had been growing.
When economists talk about a targeted rate of inflation of 2%, that is a good thing. You want a growing economy, but not too quick. That means prices grow more gradually while people earn pay raises over time.
Conversely, if prices, on average, actually decline, this is deflation. Deflation across the broad economy is a bad thing. During the Great Depression, we experienced deflation. Assume a loaf of bread cost one dollar. However, because of a weak economy and people acting out of fear, they hang on to their cash. In doing so, a grocer trying to sell bread drops the price to eighty cents. This plays upon peoples’ fears. When they see prices dropping, they think the economy will continually weaken and hang on to their cash. This restricts economic growth fueling a downward spiral.
Further adding to the confusion, when we talk about inflation, we do so as a one-size-fits-all concept. If the inflation rate is 3%, we assume it impacts all people the same. However, this is quite deceptive.
BLS classifies expenditures into more than 200 categories, across eight major groups. They are food/beverage, housing, apparel, transportation, medical, recreation, education, communication and other goods.
There is much subtlety when looking at 200 different categories. If one person rents a house while another buys a house, the impact may be quite different.
Additionally, inflation impacts people differently depending upon age and station in life. Assume a couple in their 30’s are raising two kids, while paying off college loans, buying a car and financing a house. At the same time, their 70-year-old neighbors have no kids, a paid off home and paid off car.
The couple in their 30’s are far more affected by many different types of inflation. Conversely, the 70-year-olds are not as worried about housing inflation or the cost of college. But medical inflation will certainly get their attention.
Another example is gasoline. If a person commutes sixty miles daily, the price of gas is big. However, if someone works from home, the impact may be modest.
It is no surprise that people who live paycheck to paycheck are most vulnerable to sizable swings in inflation. They must have a place to live and access to food and medicine. If inflation spikes in these categories, it is extremely punitive to those with the least flexibility in their budgets.
While we obsess over increases in food prices, we forget to factor in pay raises. Unfortunately, the relationship between inflation and pay raises is not precise math. For most of the pandemic, pay raises failed to keep pace with inflation. This made it hard to maintain purchasing power.
Lastly, even with the benefit of hindsight, the decision to stimulate the economy during the pandemic remains quite controversial. There is no such thing as “average” inflation. As bumpy as inflation has been to deal with, it was clearly better than a spiraling economy, high unemployment and deflation. That said, when you stimulate the world’s largest economy, you boost certain assets. In the process, those with financial assets have seen their assets increase to record levels. This has increased the gap between the haves and the have nots.