I recently received the following question:
Please explain to me how my cost of living can increase by 10-15 percent, grocery bills, fuel, energy, clothing, etc. yet my income only increases about 2-3% which typically matches inflation. I have talked to many people about this and a lot of folks feel the same way, how can inflation only be 2-3% when the cost of living keeps going up 4-5 times that number. I am a college student, but only in my first few years so please explain this in basic terms so that I may understand.
Thank you tremendously,
This is a common question– often, it is phrased as “What is the real inflation rate? Who do I believe?”
The Government’s alternative explanation is that everyone’s expenditures are different, and they track 80,000 additional items and take the average based on percentage usage. For instance, they may estimate that the average family spends 5% of their income on gasoline, so they calculate the CPI based on 5% gasoline and 1% bread and 10% rent, and whatever. (I just made up numbers, not actual government percentages). However, if you drive a lot more than average, you might spend 10% of your income on gas, and so your averages would be different. Also, education has increased much more than most other items, so students would be affected more. (see our article on education inflation).
Is inflation all in your head?
Psychologists might say that your perception is the problem. You only focus on the items that are going up and ignore all the balancing things like computers, electronics, etc. that are going down. This is human nature and is actually a survival mechanism.
Imagine you are walking along, and you get a small pebble in your shoe… before long, that is the primary focus,and you can think of nothing else. This “irritant” becomes much more prominent in your perception than it really is. When it was among all the other pebbles on the path, we didn’t even notice it.
This is good… when it comes to most things because it allows us to get rid of the pebble before it causes a blister on our foot. However, regarding inflation, it may skew our perception as we focus on the irritants and ignore the “blessings”. It might also relate to whether you are a “glass half full” or a “glass half empty” sort of person.
Another problem is that recently the price of highly visible things like gasoline has gone up significantly in a short period of time, so we say to ourselves, “see how much prices are going up… gas went up 20 cents in the last month alone”. However, we forget that it went down 20 cents over a three-month period six months ago. This means that gasoline prices might actually be at the same level as a year ago. But our short-term focus only lets us see the recent increase. As of this writing, that is precisely the case… gasoline was over $3.00 a gallon a year ago, then it gradually fell back to almost $2.50 then rapidly jumped back to around $3.00.
On an annual inflation basis, gasoline inflation would be zero, but it might be 10% on a monthly basis. Mentally, however, we say, “see, gas is up 10% in a month, how can inflation be only 3%?” But when gasoline prices are falling, we tell ourselves ahhhhhhh prices are returning to where they “should be”.
What’s the real explanation of inflation?
Perhaps, a little of each. I certainly won’t say the Government isn’t fudging the numbers, but I do know that our perception is one factor and our usage patterns affect our personal inflation rate.