Is inflation still a threat? The surprising truth behind the numbers

OPINION — Just two years ago, inflation dominated economic discussions both in the media and at dinner tables. At its peak in June 2022, inflation soared to 9.1 percent, a figure that sent shockwaves through the economy and significantly dented President Biden's approval ratings. By December 2023, inflation had dropped to 3.4 percent — a remarkable turnaround by any standard.

The latest inflation report shows a rate of 2.9 percent for the 12-month period ending July 31, 2024. This has led Federal Reserve chair Jerome Powell to say that the Fed will likely cut interest rates in September.

Why, then, do so many consumers remain convinced that inflation is still a major issue? An Aug. 20, editorial in The New York Times from Paul Krugman, "What Happened to Inflation," provides some insights.

Krugman reminds us that high inflation was largely a byproduct of COVID-19 disruptions. The pandemic caused significant shifts in both how we spent our money and how businesses operated. Supply chain snarls, labor market mismatches, and a surge in demand for goods over services all contributed to the inflationary pressures. But as businesses adapted and the economy adjusted, these pressures eased, leading to the significant drop in inflation we see today.

Additionally, Krugman argues that the sharp decline in inflation is a significant vindication of the Biden administration's economic policy. Any discussion of the reduction — without the economic pain many predicted — should acknowledge that it was due in part to deliberate policy decisions that steered us back to economic stability.

Yet, despite these positive developments, many people continue to feel uneasy about the economy.

One factor, which Krugman also addresses, is the perception that inflation coming down should mean that prices also drop. In reality, it means they increase more slowly or level off. I've even heard the argument that economic policies should try to reduce prices back to their pre-inflation levels, something that is not feasible and would have undesirable consequences.

Another part of this uneasiness comes in part from cognitive biases that skew our perceptions. Two of these that I've discussed previously are frequency bias and loss aversion. We're more likely to notice the continuing high prices of items we buy frequently, like groceries, than the lower prices for less frequent purchases like electronics. We also tend to feel the pain of losses more acutely than the joy of gains, so the sting of paying more for bread overshadows the relief of a higher paycheck. It's human nature to dwell on the negatives, even when the overall picture is improving.

These same biases may also affect our perception that prices have risen more than wages. It's true that, since 2019, average consumer prices have risen by 22.6 percent. At the same time, average hourly wages have risen by 25.3 percent and wages for nonmanagerial workers by 28.2 percent. Average purchasing power has actually increased.

Obviously, these figures offer no comfort for someone if their own salary has not increased in line with the averages. Inflation often feels more personal and immediate than other economic indicators, in part because we perceive it through the lens of our own circumstances. If you are paying 2024 grocery prices on a 2019 paycheck, your perception of the economy is not going to be rosy. Your neighbor whose employer has increased salaries significantly will likely feel more optimistic. Neither view is necessarily based on broader economic data.

What that data indicates is that inflation has normalized, wages have risen an equal or greater amount than prices, and the economy is in a far better position than many had feared. It is worth acknowledging that the worst of the inflation crisis appears to be behind us.

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