Inflation has cooled significantly in recent months, yet many people are still paying more for a lot of things. That’s because easing inflation doesn’t actually mean prices are falling — it just means prices are rising more slowly. And that’s a good thing for the economy.
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Inflation has cooled significantly in recent months — but you may still find yourself paying more at the grocery store or the doctor’s office than before the pandemic.
It’s a big reason why people are unhappy about the economy, as this recent Gallup poll revealed, even if by many measures the economy is actually doing quite well.
So what does it actually mean when inflation is easing?
Simply put, falling inflation, or “disinflation,” means prices are rising more slowly than they had been. That’s a good thing. Grocery prices have climbed less than 2% in the last 12 months, compared to a 12% jump the previous year, which gave many people sticker shock at the supermarket.
What many people want to see, however, is “deflation,” when prices actually come down. Falling prices are not generally good for the economy, though.
Here are four things to keep in mind.
Don’t Dis the Disinflation
Inflation has fallen sharply — from a peak of 9.1% last year to just 3.1% in November.
That’s giving the Federal Reserve a lot of comfort, even though policy makers still want inflation to ease more.
On Wednesday, the Fed signaled it may start cutting interest rates next year, triggering a big rally in the stock market. Fed officials are aware, though, that many Americans aren’t celebrating just yet.
“Most Americans are not just looking for disinflation,” Fed governor Lisa Cook said last month, during a speech at Duke University. “They’re looking for deflation. They want these prices to be back where they were before the pandemic.”
People usually welcome falling prices for things, like eggs for example. But when price falls become widespread they can be a sign of economic distress.
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Cook said she understands that sentiment and hears similar complaints from her own family.
But deflation is not the Fed’s target. The central bank actually prefers rising prices, so long as they rise slowly enough that people don’t have to worry about them.
Why falling prices are not necessarily good
Falling prices may sound like a good thing, but widespread price cuts — what economists call “deflation” — is typically a symptom of economic distress.
Japan has struggled with deflation since the early 1990s, leading to years of subdued economic growth.
The U.S. did experience deflation in the early months of the pandemic, and it wasn’t pleasant. Prices plunged because people were stuck at home, unable to go shopping or out to restaurants. Sure, gasoline was cheap, but only because most people weren’t driving anywhere.
If deflation becomes entrenched, it can be a drag on the broader economy. While it’s always fun to get a discount, when prices are steadily falling across the board, it tends to discourage consumption — which is the biggest engine of U.S. economic growth. Why buy a washing machine today if it’s going to be cheaper next year?
That’s why the Fed’s goal for inflation is not zero but 2%, with prices rising fast enough to avoid deflation but slowly enough that most people don’t spend much time thinking about it.
Some prices are falling
The inflation rate — 3.1% in November — tells us that overall prices are still rising.
But that figure is compiled from thousands of individual prices, some of which are going down while others are going up.
Over the last year, for example, the price of eggs has fallen more than 22%. Air fares have dropped more than 12%. And the price of smartphones has fallen by 14%.
Some of these price declines reflect the unwinding of earlier price increases. Egg prices, for example, soared when avian flu hit the country’s hen houses, then fell back to earth as laying flocks recovered.
Other prices are adjusted for quality improvements. A smartphone today might sell for the same price as one did two years ago, but if today’s phone has a much better camera, that might be counted as a price cut.
In any given month, some goods and services will show “deflation,” but that’s usually offset by rising prices of other items.
Rising wages will help
Inflation is particularly unsettling when the cost of living rises faster than people’s paychecks, and families struggle just to maintain their standard of living, let alone get ahead. That was the case for many people in 2022, when inflation hit a four-decade high.
For the last seven months, though, average wages have risen faster than prices. If that continues, workers should be able to gain ground.
“That might help improve the mood of people,” Fed Chair Jerome Powell said this week.
Of course, most people tend to think of wage increases as a reward for their own hard work, while price increases are something that’s inflicted on them.
Still, a trend in which wages are outpacing inflation should produce a happier outcome over time — and eventually, perhaps, make people feel less grumpy about the economy.
