If the inflation rate has come down, why aren’t prices lower?

Inflation has been a major factor in the financial world (and part of our daily lives) for the past four years, and could potentially be an issue again in the coming year. The Federal Reserve in the United States has been cutting rates as their inflation rate has been declining, and the Bank of Canada has brought inflation back into its target range. Both central banks have seemingly moved on from focusing on inflation, and are now paying more attention to the economy and labour market.

This leaves many people confused, as the cost of almost everything has gone up quite noticeably in the past few years and hasn’t come down yet. So, it’s a fairly common and valid question to ask why prices haven’t been coming down as the inflation rate has been decreasing.

How Inflation Is Measured

The big reason why it doesn’t make sense that prices are still high at the same time the inflation rate is coming down is mainly due to the way the inflation numbers are reported, as it arguably is a bit misleading.

When inflation is measured and reported, it is almost always comparing prices on something this year to prices last year (or month-to-month) on that same thing, which gives you the annual (or monthly) inflation rate. The problem is that it never measures prices for that item compared to 5 years ago, or 10 years, or even 20 years ago.

This means the year-to-year increase in prices can be getting smaller while overall prices are still increasing every year. To say it another way, prices are still going up, just in smaller amounts every year. That’s what a lower annual inflation rate means in reality.

A much more intuitive and relatable measure of inflation is seeing it on a cumulative basis, which shows where prices for something are now compared to prices 5/10/20 years ago. Seeing things from this perspective will line up more with people’s reality of remembering how much something was “back when I was young”, or regardless of your age, “pre-pandemic”.

While this chart shows UK inflation data, it does a great job at illustrating the difference between the annual (yearly) inflation rate and cumulative inflation:

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It is somewhat funny (but also a bit sad) that we don’t even have to remember too far back for when prices of most things were noticeably lower than they are now, as it feels like we’ve had 10-15 years of inflation squeezed into 3-4 years of living. To give a better perspective of how the cost of living has gone up over a longer period of time, here is a look at US cumulative inflation since 1982-1984:

A closer look at US cumulative inflation from 2007-2023 shows how big the jump was in the past 3-4 years:

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Another good article on cumulative vs annual inflation can be found here:  https://www.forbes.com/sites/johntobey/2024/03/26/the-federal-reserves-folly-an-inflation-rate-of-20/

Adjusting For Income

While it’s a bit depressing to see how much the cost of living has gone up over time (and even just recently), an important thing to keep in mind is that people’s income generally goes up over time as well. If you are an employee, you may get an annual pay raise, receive a promotion, or find a new job over the course of your career. If you are a professional or business owner, you hopefully will see your income increase over time as you gain experience in your profession or as your business becomes more successful.

What Can Be Done?

Where that leaves us is in an endlessly escalating cycle of prices and income, as central banks want to keep inflation growing every year at 2-3%, rather than seeing a nasty recession that causes large numbers of job losses and sends inflation into negative territory.

What that means is the only real way to “beat inflation” is to outearn it. Some potential ways of doing this include:

• working more hours or increasing sales/revenues
• seeking a pay raise or promotion
• searching for a better-paying job
• investing to generate supplemental income

If you are finding you can’t keep up with the rising cost of living, then perhaps this article helps you reflect on your employment and income situation and make the decision to seek a change that helps lift your income to a higher level. Alternatively, if you have investment money that you would like to use to generate additional monthly income with, we’d be happy to discuss this further and help you achieve that objective.

^{This information has been prepared by Dennis Rubeniuk, who is an Investment Advisor for iA Private Wealth Inc. Opinions expressed in this article are those of the Investment Advisor only and do not necessarily reflect those of iA Private Wealth Inc. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Canadian Investment Regulatory Organization.}

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