Sheldon H. Jacobson: If inflation is down, why are so many people unhappy?

The Federal Reserve reports inflation is down, though it continues to remain above its 2% target level. The most recent report showed inflation was hovering around 3.5% (year-to-year), from a high of 9.1% in June 2022. Yet many people do not feel good about their financial situation, with inflation one factor driving such sentiments.

Despite what the Federal Reserve reports about lower inflation, most people are less interested in inflation being down and more interested in prices themselves being lower. Part of this perception is based on a misunderstanding of inflation and its relationship to prices.

Inflation is a measure of how prices are changing over time. When inflation spikes to 9% over a given year, this means that prices increase by 9% on a year-to-year basis. Now that the baseline for prices is higher, they will remain so unless deflation brings them down, something that is not likely to occur anytime soon and could be catastrophic for our economy.

High inflation, even if it occurs for a short period, bumps prices up. This is captured by the Consumer Price Index (CPI), used to measure the price of goods and services, and measure inflation. These goods and services include numerous components, such as food, clothing, rent or home costs, utilities, communication, fuel, and transportation. In any given month, the price of some of the components may increase, while others may drop. Some components tend to be more stable, like food and rent, while others may be highly volatile, like energy.

How people feel about their finances is driven in part by expectations. News of lower inflation does little to assuage people’s expectations and anxieties about higher prices, even if prices are no longer rising at a fast rate. The problem for many is that prices are higher today than they were in 2020, and their ability to purchase items they want, or need, is more limited today than it was four years ago.

Aggregate economic measures suggest the economy is doing quite well. The stock market, as measured by indexes like the S&P 500, has reached several all-time highs this year. Unemployment has persistently stayed below 4% for several months. The Gross Domestic Product (GDP) continues to grow, albeit modestly.

Yet aggregate economic measures do not put food on the table, pay utility bills or put fuel in the automobile.

This creates a dilemma for the current administration, and an opportunity for Republicans to exploit how people feel about their finances to blame the president for their woes. Yet a $25 trillion economy does not turn on a dime, and supply chain woes during the pandemic created fewer goods being chased by more money, an environment that stoked inflation. This effectively established a new steady state baseline, which neither Republicans nor Democrats can do much to change now. It also creates an environment that businesses can exploit by keeping prices high while costs moderate.

Given that Election Day is just over six months away, people are prone to vote based on the economy. Yet people’s perception of the economy is often based on how they feel about their personal financial situation. It does not matter if the stock market is soaring or inflation is subsiding. If they cannot get by and meet their personal expectation, they will tend to vote for change, even if such a vote will likely change little for them. Indeed, the factors that can help people feel better about their finances do not reside in Washington, but in their head, based in part on their own expectations and how they manage what they have, rather than what they wish they had.

Sheldon H. Jacobson is a computer science professor at the University of Illinois Urbana-Champaign. A data scientist, he applies his expertise in data-driven risk-based decision-making to evaluate and inform public policy.