Last week’s Courier Herald Column:
We got some good news last week. Or, at least, the news on inflation was less bad. When dealing with the dismal science of economics, “less bad” is good.
The annualized inflation rate for the month of April dropped below 5% for the first time in two years. The accelerating rate surpassed the Federal Reserve’s target rate of 2% the Spring of 2021, and peaked at 9.1% last June. A drop from 9.1% to April’s reading of 4.9% shows progress, but we’re still more than double the Fed’s target rate.
It’s become clear from observing news reports, political claims, and random social media comments that too many of us don’t really understand what these numbers mean. The biggest tell is when you see someone asking when prices are going to come down.
What we’re currently experiencing is disinflation. That means prices are still going up, but they’re going up at a slower rate than they were. If this rate were to hold steady, your cash money would be worth 5% less a year from now than it is today.
This is the reasoning for cost of living adjustments (COLAs) given to recipients of programs like social security, some defined pension programs, and many public and private employers. COLAs ensure that for the same work (or pension), you can generally buy the same basket of goods used to measure inflation.
The most noticeable place we see inflation is at the grocery store and at the gas pump. This is why when you listen to explanations of the inflation rate, you’ll hear one rate for “core” inflation that excludes food and energy. We’re quite familiar with the prices of fuel and food having wild spikes upward, and then usually having slower and more gradual price declines.
The core index that deal with items which have less volatile prices, don’t tend to come back down. Inflation in our modern economy is more or less permanent. Otherwise we would experience deflation instead of disinflation.
Deflation would be an entirely different set of problems. As much as we would enjoy the lower prices, the expectation that the things we buy or invest in would be worth less later than now creates sellers today while pushing buyers into a pattern of delay. Why would you buy anything today that you didn’t absolutely need if you could get it cheaper tomorrow?
Deflation means asset prices for housing and property are in a steady decline. Deflation means shrinking wages.
This creates a spiral where consumers don’t spend, businesses don’t invest, and thus economic activity begins to grind even more slowly. The American economy – which is about 70% consumer spending – actually relies on a little bit of inflation as the motivation to keep it all moving and growing.
When the inflation rate is between 1.5% and 2.5%, as it was from roughly 2012 until early 2021, you get an ideal scenario. The money you have is maintaining most of its value, while the cost of borrowing money to make even more money is a low barrier for investors to grow their businesses and employ more people.
That is, in theory, what we’re trying to get back to. What we need to understand is that things will be different, and we’ll have to adjust to current higher prices on most items.
As we’re beginning to move past the unintended consequences of the pandemic shutdowns the follow on stimulus programs, there will be new headwinds that will make it more difficult to get the inflation rate to half of what it is today.
The pandemic exposed national economic and security risks to having so much of our supply chains in other countries, especially the amount of our manufacturing that is dependent on China and their ruling Communist Party. Efforts to “on-shore” these supply chains will result in higher prices for the same good, providing a headwind to inflation fighting efforts.
The net result is this: The problem is not as bad as it was a year ago, but we’re nowhere near where we need to be as of yet. Equally importantly, we need to understand that the goal is steady and stable prices, not a rollback to 2020 price levels. In the interim, pace yourself as we grind from the economy hopefully moving from “less bad” to actually good again.