Bye bye inflation. We hardly knew you…

With the Federal Reserve at last reversing course and lowering short-term interest rates by 50bps this week, we can officially say that a chapter of US economic history has ended. Inflation - the economic monster-under-the-bed, the Sauron of macro, the bogeyman of governments everywhere since the early 20th century, and the purported source of all woes since the orgy of federal pandemic spending in 2020 and 2021 – has receded close to its startlingly low levels of the 2010s. In short, inflation is over.

You wouldn’t know that by listening to voter concerns. Inflation and cost-of-living remain high on the agenda of top issues. But as we know from past experience, public attitudes lag public data, meaning that it takes anywhere from 6 to 12 months after the data has registered meaningful shifts before people begin to adjust their views. That’s why so often people believe that the economy is negative many months or even a year after it started becoming negative and remain convinced that the trends are negative many months after it begins to turn positive.

Inflation clearly was a significant shock from the middle of 2021 until the last half of 2023. Whether measured by the traditional consumer price index (CPI) or the preferred Personal Consumption Expenditure index (PCE), inflation went from less than 2% in 2019 to more than 8% (CPI) in mid-2022. The pocket-book reality was felt acutely in food prices, which along with gas prices are the most obvious day-to-day experience most of us have with rising or falling prices. In August of 2022, food inflation, both at home in terms of grocery prices and at restaurants and take-away food, reached 11%, which was the highest it had been since 1979.

While actual wages and take-home pay for the vast majority of Americans also went up between late 2020 and late 2022 care of massive government spending and child-tax credits, those increases weren’t enough to offset inflation overall. Hence the widespread anger and panic about untenable cost of living. Add to that the fact that there was one weird effect of the Fed starting to raise interest rates in 2022: when the Fed raises rates aggressively, the housing market tends to freeze. After all, why buy a home when mortgage rates are going up if you can wait? People need somewhere to live so they tend to rent while they are waiting out the mortgage cycle. That then puts pressure on rentals, and indeed, rents went up a lot in 2021-2023, in many areas at the fastest pace in a hundred years! And when rents go up, inflation as measured by the government also goes up, because rent is about 30% of the CPI. So, one weird effect of the Fed raising interest rates to fight inflation is that it actually causes some short-term inflation in the form of higher rents.

Anyway, that whole cycle has now ended. In truth, the inflation spike lasted about 2 years, from early 2021 to mid-2023, with its high point lasting a few months of 2022. But after twenty years of no inflation and after a pandemic that scared the shit out of all of us, that inflationary spike was deeply unsettling, to individuals and to policymakers. The Fed at first shrugged off the rise in inflation in late 2021 and called it “transitory,” and when transitory proved to be more than a few months, it acted aggressively to raise the cost of money.

I’ve written over the years that the Fed remains one of the few government institutions still staffed by mandarins. They aren’t power hungry, or greedy, or particularly ideologically in the partisan sense. They tend to be driven by a real passion to guard the economy against disaster. That is honorable. But honorable is not an excuse for being wrong, nor does it let the Fed off the hook for a certain type of technocratic arrogance that only they stand in the way of economic abysses.

A great read on Inflation from 2022

So much of what happened with inflation was a specific product of trillions of dollars of government spending during the pandemic, added to trillions more worldwide. In fact, governments spent more to offset the economic harms of the pandemic in 2020-2021 than any governments had ever spent to bolster domestic consumption, including in times of war. Then, as restrictions eased in 2021, a few billion people around the world started spending a lot of money. Supply chains couldn’t keep up, and pocketbooks were flush. Voila, prices went up.

That had very little to do with interest rates, and we will never know if the arc of inflation would have been any different had the Fed done much less and accepted that “transitory” is an imprecise term that could mean a few months and many months but at least clearly meant that the causes of inflation were particular and specific and would therefore wane when those specific inputs stopped. Or to put it simply, once the money from all the stimulus bills was spent, inflation would recede on its own. And it did.

Yet people are not governed by statistics. They experience the world directly, through the prices they see and the costs they incur. Those costs soared for 2 years, so it is hardly odd that most of us still feel inflation as a serious concern even if it has now dropped precipitously.

That said, our collective feelings and fears cannot be and should not understood as a gauge of reality, or at least not the primary gauge of reality. The reality of our economy is that inflation has ceased to be a problem. That is not debatable – which won’t stop most of us from debating it.

The reality of our economy is also that the shock of the pandemic and inflation brought to the fore the fact that a considerable portion of people in an affluent country are too on the edge when it comes to their incomes versus their needs and wants. Some of that is on us individually: dispassionately separating needs from wants is hardly any of our strength. Some of that is on our system: no one in an affluent society should worry about adequate housing, healthcare and food security. And humans being what they are, all of those become muddled together, especially in an election year. But let’s be clear: there is no significant inflation as of now. That doesn’t mean that prices will come down from the highs they reached in 2022 and 2023. A drop in prices would be deflation, which comes with its own set of pros and cons, mostly cons. The end of inflation means the end of prices rising beyond incomes and overall growth, not a return to prices of the past.

And how we feel about the economy versus what the numbers tell us, which I wrote about a few months ago, that remains a yawning gap. It can, however, be narrowed if each of us take a deep breath and try to untangle needs versus wants, fears versus hopes, and heated political hyperbole versus lived reality. And if enough of us do that, it will go a long way to all of us having a clearer picture of the world we inhabit.