Inflation Has Come Down, But High Prices Are Here to Stay

With the widely-feared recession never materializing, U.S. GDP growing steadily and an unemployment rate of around 4 percent, it's hard to argue that the U.S. economy is not doing at least reasonably well. Add to that the fact that stock prices are near record highs and you'd think that Americans would be delighted about their country's resilience in the face of so many crises around the world. And yet, 46 percent of Americans describe current economic conditions as “poor” and more than 50 percent say they're worse off than they were four years ago, according to a recent Gallup poll. One of the main reasons for this dissonance is probably inflation, or, more accurately, what the past two and a half years of elevated inflation have left us with: high prices. Because despite inflation cooling to 2.4 percent or the lowest level since February 2021 in September, sticker shock is still real as many prices have not and probably won't come back down to pre-crisis levels.

Whenever we're discussing inflation coming down, it’s important to distinguish between disinflation and deflation. What we’ve seen over the past two years and hope to see more of is disinflation, i.e. a deceleration of price increases (yes, increases), or - mathematically speaking - a negative second derivative of consumer prices. For the overall price level to actually come down, the first derivative, i.e. the inflation rate itself would have to drop below zero, which would signify deflation. While the Fed desperately fought for inflation to decelerate, it is aiming for 2 percent inflation, not deflation, because the latter creates a whole set of problems on its own. 

As the following chart shows, the rate of inflation (red line) has come down quite a bit from its June 2022 peak of 9.0 percent. Consumer prices (blue line) have continued to to climb, however, and are now 21.5 percent higher than they were in January 2020, just before the start of the Covid-19 pandemic. So while some prices will or have already come back down from their peaks as supply chain disruptions ease and global crises recede, prices will likely continue to rise at the aggregate level, albeit hopefully at a slower rate. Moderately rising prices are not a problem as long as wages keep up with those price increases. While that hasn't been the case from April 2021 to April 2023, when real wages in the United States actually declined on a year-over-year basis, real wages have returned to growth since then and are now slightly higher than they were before the pandemic.