The Hard Truth About Inflation

July 20, 2023

 

Q: I keep hearing on the news that inflation is improving, but I don’t really see this meaningfully changing my day-to-day experience. When will prices come down and things get back to normal?

 

A: Inflation is one of the most familiar terms in all of economics, but is not always fully understood. Though, most of us agree that high inflation is a problem that needs to be addressed. In fact, in a recent poll done by Pew Research on the most concerning problems in the US currently, inflation came in as the top concern for the country overall.

 

Over the past two years we have felt it at the pump, the grocery checkout, restaurants, and really anywhere we need to spend money on a consistent basis because there are so few areas that haven’t been dramatically affected by inflation. Rapid runaway inflation is a major detriment to a thriving economy and a predictable environment, but is inflation always a bad thing?

 

The Federal Open Market Committee (FOMC), a division of the Federal Reserve, seeks to maintain an inflation rate of 2% and sees this as a healthy rate of price growth in an economy. The Federal Reserve believes this is the proper rate most consistent with their overarching goal of maximum employment and price stability. A consistent and predictable trajectory of price growth allows businesses and households to do long-term financial planning with more accuracy, contributing to an overall stable economy. Alternatively, sustained low levels of inflation or deflation, which is a decrease in overall prices, can be an economic problem as it usually is associated with higher levels of unemployment, lower consumer confidence, and low demand.

 

The June numbers for inflation were released last week and the U.S. Consumer Price Index came in even lower than expected at 3% when compared to a year ago. This continued a downward trend that peaked last June at the height of 9% and has fallen every month since then. Core inflation, which takes out volatile items like food and gas, was also down to its lowest point since October of 2021 at 4.8%. This is great news overall, but there are many people wondering when prices will “get back to normal” and the unfortunate answer is that they likely will never get back to pre-pandemic prices, and frankly, the Federal Reserve isn’t targeting that at all.

 

For the prices of our goods to actually fall in real terms, we would need to see deflation occurring, which has only happened for two brief time periods in the last 25 years, one being after the 2008 financial crisis. Instead, what we are actually seeing is called disinflation, which is a decrease in the rate of inflation, but is still a net increase in prices. The reason why we don’t feel like prices are returning to normal is because they aren’t, they are just rising at a slower and more sustainable pace.

 

The actions of the Federal Reserve, improvements in the global supply chain, and a host of other economic realities have helped bring this rate down to a more long-term sustainable level of increase, but this is only a part of the effort. The best way for people to retain or increase purchasing power is through wage growth moderately outpacing inflation. There is also good news on this front. This month was the first since March of 2021 in which wages materially outpaced price growth, coming in at more than 1% above the rate of inflation. This is a welcome development as real wage growth has barely budged for decades.

 

While these numbers are promising, it is likely that the hardest part of this effort against higher-than-average inflation is still ahead. The Federal Reserve has estimated that their long-term goal of 2% inflation will not be achieved until 2026, with a potential for smaller interest rate hikes still on the table in the near future. In the meantime, we can celebrate the little wins and know that we are approaching a return to a more sustainable inflationary environment, even as we are still coming to terms with this new normal and what it means for our businesses and households.

 

 

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Zach Harney, CFP®, CIMA®, AIF® is a Wealth Advisor at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Zach Harney, 2340 Garden Road Suite 202, Monterey, CA 93940 or email zach@montereypw.com.