Leftover inflation is now the biggest problem
Inflation is slowing, which is obviously good for everybody. But consumers are still grappling with price hikes from the past two years, which have outpaced earnings and left many Americans falling behind.
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What is the outlook for inflation in the next six months?
The annual rate of inflation dropped to 4% in May, down from 4.9% the month before and a peak of 8.9% last June. The Federal Reserve wants inflation around 2%, and it also wants "core" inflation, which excludes the volatile food and energy categories, to be considerably lower. Prices are stabilizing rapidly, however, and inflation might be back in the comfort zone by this time next year.
Consumers, however, still have to grapple with the cumulative effects of two years' of inflation, since most prices that have risen have stayed at elevated levels. During the last two years, prices overall have risen by 13%, while earnings have risen by just 10%. So the typical paycheck buys less.
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What is the effect of the pay hikes of workers to the inflation rate?
The cost of many necessities has risen by more than overall inflation during the last two years. Housing, the biggest portion of consumer spending, is up 14% during the last two years. Groceries are up 18%. Those two categories alone account for nearly 50% of the typical family's spending.
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What was the percentage increase in shelter prices over the last year?
Economists have cheered the rapidly slowing pace of inflation, and upbeat investors have pushed stocks into a new bull market. The Federal Reserve has been aggressively hiking interest rates to get inflation under control, and it now seems likely to stop. That means breathing room for corporate earnings and improved odds that the Fed can manage prices without choking growth so much it causes a recession.
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What policy measures are being taken by the Federal Reserve to mitigate rising inflation?
Yet consumers remain grim, with some confidence indexes at recessionary levels. Consumers are suffering what you might call post-inflation stress disorder, which certainly makes sense. As the inflation rate slows, the pain of rising prices diminishes. But a slowing rate of inflation is not the same as prices that are actually falling, allowing consumers to regain lost purchasing power. The slowing inflation of the past year only means that purchasing power is diminishing more slowly. Price shocks remain.
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Only two of the spending categories we track have gotten cheaper during the last two years: electronics and rental cars. Those are small slices of spending that don't offset price hikes elsewhere.
A few other categories have risen by less than earnings, including important ones such as health care, prescription drugs, and college tuition. That's a bit of a break for people who need to spend money on those things. But again, it doesn't offset the higher cost of housing and food.
One upbeat note for consumers: With the decline of the inflation rate to 4%, average hourly earnings, which are rising at a 4.3% annualized rate, now outpace inflation for the first time since March 2021. Nobody's going to notice such a tiny, one-month gain on inflation. But if real wage gains accelerate and last for a while, people will gradually start to feel better. It could take years, however, before Americans feel they've caught up with inflation, and outrun it for good.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman