Understanding Inflation's Impact: Why Prices Still Feel High
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Chapter 1: The Fed's Perspective on Inflation
Recently, at the annual Jackson Hole conference, Jerome Powell, the chair of the Federal Reserve, declared a victory over inflation. The central bank reported that inflation was on track to meet its 2% target, suggesting a return to price stability. Consequently, concerns shifted towards a weakening labor market, potentially paving the way for interest rate reductions in the near future.
However, if the Federal Reserve believes that inflation has been successfully managed, why do many Americans feel as if everyday life has become unaffordably expensive?
The key issue lies in the Fed's focus on the rate of price change rather than the actual price levels experienced by the average person. Although the year-over-year inflation rate has dropped significantly from over 8% in 2022 to around 3% now, prices have not decreased. There has been no deflation; rather, we transitioned from rapidly rising prices to a slower rate of increase—yet prices continue to climb.
The chart below illustrates this point. Since the end of the pandemic, prices have surged by over 20%, while income levels have not kept pace with these rising costs.
While the rate of price growth has stabilized, the actual prices we face in our daily lives remain significantly higher than they were just a few years back. Even accounting for income growth, the average individual is effectively poorer now.
Unless we enter a prolonged period of deflation, the costs of essential goods and services are now permanently elevated. This implies that, due to the economic shifts of the past four years, consumers will consistently spend 20% more than pre-COVID levels for most items, not factoring in any future inflation.
From a financial viewpoint, considering future spending needs as a series of liabilities means that their present value has increased substantially. Consequently, retirement planning has become more costly. For those looking to purchase annuities to cover retirement expenses, the price of such financial products has risen by about 20%, exacerbating savings challenges.
The persistent nature of inflation is concerning—once prices rise, they tend to remain high, whereas income levels can fluctuate significantly. Job security and income stability are often compromised by trends such as offshoring, downsizing, automation, and the integration of AI.
Section 1.1: The Wealth Effect and Asset Prices
The Fed might argue that while lower interest rates have contributed to inflation, they have also boosted asset prices. Stocks, bonds, and real estate have all appreciated significantly over the past few years, ostensibly increasing net worth and somewhat mitigating the discomfort of rising prices.
However, this benefit primarily accrues to the wealthy who own substantial assets. For those without significant investments or first-time homebuyers, rising asset prices offer little relief. Lower interest rates elevate both asset values and liabilities, complicating financial planning. While asset holders see their net worth grow, those with more liabilities than assets face an increasing deficit.
Subsection 1.1.1: The Reality of Financial Strain
This discrepancy explains why many individuals feel financially strained. Their living costs have risen permanently, while their incomes have stagnated. Additionally, the financial and real estate assets that could support future expenses have become increasingly out of reach, leading to tough times for many.
Chapter 2: The Long-Term Implications of Inflation
The first video titled "Is the Fed Thinking About Inflation All Wrong? | Big Take - YouTube" discusses the implications of the Fed's current inflation strategy and examines whether their approach is truly effective in addressing rising costs.
The second video titled "A Great Depression By 2025? - The Man Who Called The 2008 Recession Sounds The Alarm | Peter Schiff - YouTube" features insights from Peter Schiff about potential economic downturns and their relation to current inflationary trends.