Inflation vs Prices

In my role as an educator, I’ve worn many hats over the years. It’s funny that as knowledgeable as I am about US History and Macroeconomics (the two subjects I’ve taught most often), I would never describe myself as an “expert.” There are people who know way more about both than I do.

And there are lots of people who know much less…especially about economics. There’s a reason people refer to economics as the dismal science. By most standards, it’s…well…a little boring. People have better things to do with their lives than become policy wonks.

Unfortunately, economic ignorance can have negative effects…like electing a president who is promising to decrease prices on day one of his presidency (but instead is provoking a tariff war for dubious reasons). In short, those price decreases are not likely to happen. The explanation for why is…complicated, so many people just figure (incorrectly) that the person in charge of the country would have the ability to make this change. Right?

Nope.

Again, I’m not an economist in the sense of what you’re thinking when you hear that term. But I do have an undergrad degree in Economics, and I spend 16 semesters teaching AP Macroeconomics once upon a time. Inflation and prices is one of many important topics that we covered in the course, and it’s what I’m going to attempt to provide a primer on here.

What follows here is a general assessment of how inflation and prices work. As I found myself saying often while teaching this: in real life, it’s a little more complicated. So without further ado, here we go…

Let’s start with the part most people are at least a little familiar with: inflation. Inflation is how much prices have risen from the previous year (or month, or week, etc.), usually expressed as a percentage. So when you hear that the inflation rate is 2.7%, that literally means that the measured prices of many goods have risen by 2.7% on average since last year. Some prices may have gone up. Other prices may have gone down, but on the whole. 2.7% is our rate of change.

Having some level of inflation is not a bad thing. It’s a sign that the economy is growing. If inflation grows too rapidly like it did during Covid, then we have issues. Why does it matter?

Under normal circumstances, as long as the inflation rate stays “normal,” (2-3%ish) workers’ wages will tend to also increase by at least that much. So if the inflation rate increases by 2.7%, and you get a 3% raise, you’re “better off” by 0.3%. The inflation rate didn’t matter.

What if inflation is 7%? With that same 3% raise, we are now worse off by 4%. And if this happens year over year, we find ourselves with less and less purchasing power since our bosses are not likely to be able to afford (or have the willingness) to give all employees a 7% raise every year. That’s why keeping the inflation rate at an “acceptable” level is the main thing the Federal Reserve focuses on with monetary policy.

So when the inflation rate goes down, things should get cheaper, right? Well, in a word, no. Prices tend to be sticky. (That is an actual term that economists use.) They don’t move much or easily, especially downward.

More definitions: Inflation vs Disinflation vs Deflation. We’ve already covered inflation. When the inflation rate goes down but is still positive (movement from 7% to 3%), that’s disinflation. The change in the price increases has gone down, not the actual prices. For the actual prices of products to go down over time would require deflation…a negative inflation rate. And we don’t want sustained deflation. It’s bad!

In our modern economy, the only time I’m aware of that we’ve had deflation is during recessions, and as far as my limited knowledge is concerned, that’s the only way to have all of the prices go down.

We do see price decreases from time to time. Technology is a good example. As the technology for flat screen TVs has gotten cheaper, the TVs have gotten bigger and cheaper. That’s normal.

What about the price of eggs. I’m not an expert on the market for eggs, but I’d be willing to bet the price won’t come down much, if any, over time.

So we’re stuck paying more? Probably, but it’s okay. Remember what I wrote about inflation and wages. Over time our wages tend to keep up or pass the level of inflation, as long as inflation rates don’t get much above about 3%. When inflation was 7%, things were painful but hopefully you got a little bit of a raise to help. Then prices leveled off, and you keep getting raises. Over time, your wages should increase and inflation (not prices) decrease enough that at worst it’s a wash, and at best, you’re doing a little better than the inflation rate.

One of the headings to my AP Macro presentation on inflation and prices says “In The Long Run Prices Don’t Matter,” and that is what I’m trying to get at. In the moment when prices go up, it sucks, and it may very well be difficult to pay for stuff. But over time, as we get increases in pay, and price increases (inflation) stabilize, it won’t matter anymore that the inflation rate was 7% a few years ago. Our wages have caught up to (and hopefully passed) what inflation was once upon a time.

I understand that this may not be true for everyone, which is why so many folks would like to see prices go down. I can relate. I happen to be in an occupation (teaching) in a state (Texas) where for political reasons (Republican governor didn’t get his voucher bill passed) teacher pay increases were blocked two years ago (even though the state had a multi billion dollar surplus) and the basic allotment for schools has not increased since 2019. But on the whole, many (most?) people’s wages HAVE surpassed inflation, and even though we are still paying higher prices for eggs and milk (and for mental reasons, that sucks) the burden of those higher prices should become less and less as inflation stabilizes somewhat.

Unless someone or something runs the country into the ground. Then all bets are off, and all of this will probably be incorrect. But until then…

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