Why Prices Are Probably Never Going Back Down


Key Takeaways

Inflation has fallen to a 3.1% annual rate from its peak of 9.1%, but that means price increases are just slowing down, not that they’re reversing.
The policy of the Federal Reserve is to keep inflation at 2%, not to actually let average prices fall for a long time.
Although average prices have risen 19% since February 2020, some items have gone up much faster, while others have fallen.

Inflation may be going down, but those pre-pandemic prices we remember at the grocery store, car dealerships, and department stores? They’re most likely gone forever.

That’s because prices, on average, are a one-way ticket, generally rising over time, and falling only when something has gone wrong with the economy. Officials at the Federal Reserve who set the nation’s monetary policy are determined to keep it that way.

The inflation rate has fallen to a 3.1% annual rate from its recent peak of 9.1% in June 2022, as measured by the Consumer Price Index (CPI), one of the government’s official inflation measures. But taking a longer view, how much damage have rapid price increases done? According to the CPI, prices rose 19% between February 2020 and November 2023, as the chart below shows. 

If you’ve read much financial news, you may notice that the chart looks very different from the way inflation is usually depicted on graphs. It’s much more common to show the inflation rate like this:

The first chart, based on the value of the index, shows the level of consumer prices each month. It almost always goes up, except for a few months in 2020 when gas prices plunged because no one was driving during shelter-in-place orders. Showing inflation in this way makes it simple to see the long-term trend, in which prices steadily rise.

The second chart, showing the percentage change in the index over 12 months, makes it easier to gauge how the inflation rate changes each month but can be misleading. At a glance, it can seem like prices started falling after peaking in June 2022, when in reality, they just stopped increasing so fast.

In economics jargon, a drop in the inflation rate is called disinflation, while an outright sustained drop in average prices is called deflation. The official policy of the Federal Reserve is to keep inflation at a 2% annual rate, and to avoid deflation.

As Federal Reserve Bank of Atlanta President Raphael Bostic put it in a blog post last month:

“Deflation might sound appealing. After all, who wouldn’t want to pay less for groceries next week? But it can be economically destructive. Consumers may delay purchases because they expect prices will keep falling. That can curtail overall consumption, which can prompt businesses to cut production, which in turn can mean lower profits, cost cutting, and layoffs.”

The lack of deflation may help explain why many Americans feel pessimistic about their finances and the economy even though by many measures, the broader economy and household budgets are doing better than ever thanks to rapid wage increases, Federal Reserve Gov. Lisa Cook said in a speech last month at Duke University.

“If the economy is doing better, if this disinflationary process that we keep talking about is actually in process, then why are people so upset?” Cook said. “Most Americans are not just looking for disinflation. You and I as macro economists are looking for disinflation. They’re looking for deflation. They want these prices to be back where they were before the pandemic.”

The Fed has powerful tools at its disposal to prevent that from ever happening and is willing to use them.

The Federal Reserve influences the inflation rate by putting its thumb on the scales of financial markets with its benchmark federal funds rate, and by buying and selling trillions of dollars worth of securities, both of which affect what interest rates you pay when you borrow money.

Simply put, the Fed can flood financial markets with easy money, heating the economy to prevent a downturn and layoffs. Alternatively, it can make money hard to get, throwing sand in the gears of the economy, reducing demand for products and services so that companies can’t raise their prices much and inflation hopefully falls.

In the past, the Fed has stepped in at times when it looked like deflation might set in. In the late 2000s, the central bank unleashed a multitrillion-dollar fire hose of money to quash any possibility of deflation and prevent the Great Recession from becoming a total collapse. Fed officials worked to prevent a repeat of the only past instance of prolonged deflation in U.S. history: the Great Depression.

Just because average prices are going up, however—and won’t fall anytime soon if the Fed has any say about it—doesn’t mean you won’t get a break once in a while. Within the broad CPI measure, some important prices have risen dramatically, while others have hardly budged, and still others have fallen. Most of the necessities of life, including groceries, have gotten more expensive:

On the other hand, a few things have fallen, some by quite a lot.

Still others have stayed on a pretty even keel. If inflation had stayed at the Fed’s preferred pace of 2% since February 2020, overall prices would have risen 5.5% since then. A few items have stayed close to that trend.



This article was originally published by a www.investopedia.com . Read the Original article here. .