A reader asks:
I understand everything Ben said about inflation: wages have kept pace, economic growth has been higher than in the 2010s, wages have increased the most for low-income people, etc. I understand all of this. My husband and I own a house and stocks, so we have benefited from that in recent years. That said, I still can't get over the high prices!!!
Groceries, home/auto insurance, restaurants, babysitters for kids… everything is more expensive.
So how do you get over sticker shock? Will this eventually fade away as we get used to higher prices?
The psychological component of inflation is obviously a real phenomenon.
One reason for this is that inflation is personal.
A bit like a given stock market year is rarely average, no household knows the average inflation rate announced by the government. Not only is inflation basically impossible to calculate accurately, but everyone's circumstances are different.
If you own a home, are stuck with a 3% mortgage, don't have a lot of debt, and have financial assets, you should be fine, relatively speaking.
If you are renting, looking to buy a home, need to buy a new car, or need to borrow money, this environment is deadly.
This is why so many people don't believe inflation numbers.
The average inflation rate includes a wide range of outcomes for different households. Many people have been hit by inflation through no fault of their own, while others have escaped more or less unscathed through sheer luck.
The same goes for salaries. Arin Dube calculated the change in real salary by income quintile from the end of 2019 to the end of 2023:
It's true that it's the lowest-wage workers who have seen the biggest increase in wage growth, even after accounting for inflation.
But it is also an average figure. Some do better, others worse. Some of these people own homes, some don't. Some own shares, most don't.
If groceries are one of your biggest expenses, you're in for a world of hurt:
And this inflation is not necessarily correct depending on what you buy. The Wall Street Journal looked at how the average price of various grocery items has changed since 2019:
They found that the list of staples you buy at the grocery store has increased by 36% since 2019. To be fair, you also have to adjust these prices for wages, but these are the prices people experience regularly .
There are obviously people who are saddled with higher prices due to their circumstances, but the person asking this question admits that they are doing very well financially. So why does inflation have such a psychological impact even if you're not in the struggling class?
On the one hand, wages seem deserved, while inflation seems unfair.
The loss of purchasing power is much more painful than the wage gains you see over time. Inflation is loss aversion on steroids.
The fact that inflation occurred over such a short period also plays a role here.
For example, the CPI increased by about 20% throughout the 2010s. Prices also increased by 20% between 2020 and 2023. The magnitude of the price changes is the same, but the fact that they being produced so quickly in this decade introduces recency bias.
In the 2010s, you had a chance to get used to price changes as they happened slowly over time. In the 2020s, there was a real explosion of price increases.
And even though grocery store prices seem out of control these days, the situation is much different this century:
Wages have far outpaced grocery store prices, and grocery store prices have actually increased less than the overall inflation rate since 2000. These gains occurred over time while the losses occurred immediately. Inflation is worst when it happens in a hurry.
Or look at gas prices. They are now at the same level as in September 2008:
If you adjust gas prices for inflation, they're down about 30% since 2008. But we're not feeling those inflation-adjusted gains. We only feel the losses when gas prices increase from lower levels.
The other important point to remember is that price levels rarely fall as a whole. Here is the annual inflation rate since 1950:
Prices only fell 3.7% of the time. This means that in 96.3% of cases prices increased. The worst deflation occurred during the 2008 financial crisis, at -2.1%, and it did not last.
Eventually, people will get used to higher prices.
The funny thing is that today's prices will seem low compared to future price levels.
We addressed this question in the latest episode of Ask the Compound:
Jill Schlesinger joined me live in studio to address retirement questions with retirement planning, using a HELOC for home equity, managing stocks that generate large taxable gains, l buying a new car to minimize fuel costs and how to insulate your career from robots and AI. .
Further reading:
The pros and cons of more volatile inflation