Prices don't drop when inflation eases. Why your wallet will be hurting for a while.
- Consumers should get used to higher prices on goods and services.
- Once those prices rise, the new prices typically stick.
- Easing inflation doesn't mean prices will drop. It just means prices aren't rising as fast.
When it comes to prices during inflation, what goes up, doesn't always come down.
When talking about inflation, it’s important to remember that inflation is a rate that measures how fast prices are rising. If the consumer inflation rate drops from its 40-year high of 8.6% in May, prices are still rising – just not as fast.
Consumers won’t feel immediate relief even as the inflation rate slows because many of those elevated prices are likely here to stay, said Michael Ashton, managing principal at Enduring Investments in Morristown, New Jersey.
"The price level has permanently changed," Ashton said. "Until your wages catch up (to inflation), it will continue to hurt,”
And wages have a long way to climb to catch up. In May, inflation-adjusted average hourly earnings decreased a seasonally adjusted 3% from a year ago. When combined with a decrease in weekly hours worked, that resulted in a 3.9% decrease in real wages, the Bureau of Labor Statistics said.
Inflation on used cars has dropped. Will they be cheaper next year?
The rate of inflation on used cars has fallen significantly. At one point, year-over-year used-car inflation was more than 40%, but recently it’s dropped to around 20%. But that doesn’t mean the price of a used car has fallen a lot.
"Used car year-on-year inflation is going to continue to fall over the balance of this year. Used-car prices are not," Ashton said. "The best we can hope for is they only go up 2%.”
Last year around this time, inflation on used cars was already rising. So, the math to calculate the year-over-year inflation rate starts from a higher base, hence the so-called base effect.
“The rate of change is coming down a lot because of these base effects, but the price itself is not falling,” Ashton said.
So, you may as well consider buying that used car now.
But why do gas prices drop?
Prices of items like gas and food can be volatile due to outside factors, such as the war in Ukraine, that the Federal Reserve can’t control.
So, the Fed tends to exclude food and energy prices and instead concentrate on so-called core inflation," said Nick Roussanov, a Wharton finance professor. Core inflation includes things like rent, furniture, clothing, and other goods and services.
“Once core prices go up, generally they don’t come down," Roussanov said. "In the last 40 to 50 years, we’ve never seen deflation in core goods. Most durable goods and services don't really come down in price.”
Why is the Fed determined to get inflation quickly under control?
The obvious reason the Fed is acting is that inflation is squeezing consumers, forcing them to dip into savings or credit cards to afford the recent price surges.
But there’s a long-term imperative, too.
The longer inflation outpaces wage growth, the larger the distance for wages to catch up, and the more debt and less savings consumers might accumulate to pay for necessities until that happens. And that much wage growth could take a very long time.
“What the Fed does is meaningful,” said Chris Campbell, Kroll chief strategist and former assistant secretary of the Treasury for Financial Institutions. “As prices continue to rise, budgets are eroded. If prices don’t get under control, this could be significant for the consumer forever.”
Why will prices keep rising?
Businesses are still struggling with inflation and need to pass on some of their costs. Even though supply chains have almost disappeared from headlines, businesses are still experiencing disruptions as well as labor shortages amid strong demand, said Holly Wade, executive director at the National Federation of Independent Businesses.
Over the next three months, a record high level of business owners said they’re planning to raise prices, she noted.
"Even with a slowdown in consumer spending, I don’t anticipate price cutting among small business owners, just a slowdown in the rate of increase,” Wade said. “Gas prices are a large part of the inflation picture for small-business owners, and it’s unlikely that prices there will decline significantly anytime soon.”
The national average for a gallon of regular unleaded gasoline was last at $4.857, down from a record high above $5 in June. However, most analysts expect the recent decline to be temporary, as oil and gas supplies and refinery capacity remain limited.
Additionally, modest, predictable inflation is seen as a sign of a growing economy. It incentivizes people to spend money now rather than waiting, allows wages to increase either in line or above inflation to boost the standard of living, and makes it easier for businesses to plan, according to the Federal Reserve and IMF.
What if prices dropped? Is that bad?
Price declines wouldn't necessarily be good. Although people think they want to see prices drop significantly, that would actually be a sign of an extremely weak economy, with a plunge in productivity. Negative inflation, or deflation, would likely lead to a significant rise in unemployment and wage cuts, and signify a deep recession, which no one wants.
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Economists may expect a significant slowdown in the U.S. economy, or even a recession, but they generally don’t expect the economy to sink into a deflationary period in this cycle.
Is there any good news?
There is good news.
“Wages are running faster than median inflation right now, so if gas and food just stop going up, in a couple of years, people will ‘catch up,’” Ashton said. “Assuming, of course, that they keep getting those wage increases even when they (workers) can’t point to CPI (consumer price index) at 8%.”
Median CPI, which excludes outliers, can provide a better signal of the underlying inflation trend, the Cleveland Fed says. In May, it was 5.5%, compared with 8.6% for overall consumer inflation. The three-month moving average of median unweighted wage growth was 6.1% in May, according to the Atlanta Fed.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at email@example.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.