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?”
Inflation is all in your head?
Psychologists might say that your perception is the problem, you only focus on the items that are going up and are ignoring all the balancing items like, computers, and electronics, etc that are going down. This is human nature and actually a survival mechanism.
Imagine you are walking along and you get a small pebble in your shoe… before long that is the major focus, you can think of nothing else. This “irritant” becomes much larger 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. In regard to inflation however 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 have 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 exactly 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 on a monthly basis it might be 10%. 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 personal usage patterns do have an effect on our personal inflation rate.