Inflation is cooling, but don't tell that to Americans.
Even after a year-over-year rise in consumer prices slowed to 7.7% in October from a 40-year high of 9.1% in June, consumers still aren't feeling optimistic that inflation will wane anytime soon. And in a kind of self-fulfilling prophecy, this could keep inflation buoyed and the Federal Reserve raising rates to tamp it down, some economists say.
In November, consumers' expectations for inflation over the next 12 months jumped to 7.2% from 6.9% in October, based on rising gasoline and food prices, according to The Conference Board, a nonprofit that tries to gauge what's ahead for the economy and help leaders navigate issues affecting businesses. Other well-regarded surveys also showed that Americans have a gloomy view of where inflation is headed. The most optimistic survey, from the University of Michigan, showed inflation expectations changed little last month from October, although they remained elevated.
Expectations and actual inflation can reinforce each other in these situations. When people expect higher prices, they ask their bosses for raises, which prompts companies to raise prices as they anticipate consumers being willing and able to pay more for goods.
How do Americans see inflation?
Once on the front line at the onset of the COVID-19 pandemic, Dean Blafford now finds himself at the front line again – but this time staring down inflation.
Blafford has worked nearly 30 years, including through the darkest days of the pandemic when most everyone else was told to stay home. He’s a butcher at the Stop & Shop in Brooklyn, New York, so he couldn’t work from home.
He survived that, but just like the pandemic took its toll, so is inflation. It’s not just the short-term everyday adjustments – "staycations" instead of vacations, kids sharing a car instead of getting their own car – but the disappointment of not being able to retire early.
Instead of enjoying waking up late and taking walks, he’s at the daily grind for the foreseeable future as inflation sticks near 40-year highs.
He has worked, saved and didn’t spend extravagantly. Yet, when the company offered him and fellow members of his union a buyout this year, he had to decline.
“I would have loved to get out at 55 (years old) with 30 years in, but I would’ve had to take another job,” he said.
He wasn’t the only one. “A lot of people in the union opted out,” he said, for the same reason – inflation.
Why does how Americans see inflation matter?
Actual inflation partly depends on what we expect it to be.
People’s behaviors change depending on how they view inflation. If they expect inflation to remain high for some time, they may ask for higher pay, for example. The increase in wages, or costs, may lead businesses to raise prices, and the loop restarts, making inflation a self-fulfilling prophecy.
Companies already forecast they will raise salaries by 4.6% next year, up from an actual spend of 4.2% this year and the largest amount since the Great Recession in 2007, according to the latest Salary Budget Planning Report by WTW of more than 28,000 firms worldwide, including 1,550 from the U.S., between Oct. 3 and Nov. 4. Most companies (77%) said they were reacting to inflation, it said.
“The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched,” or firmly expected, Fed Chair Jerome Powell said after the Fed policy meeting last month.
How can the Fed keep inflation expectations anchored?
“The thing we need to do ... is to use our tools forcefully but thoughtfully and get inflation under control – get it down to 2% – get it behind us,” Powell said.
That means raising rates.
Hiking until it hurts: Federal Reserve's rate hikes hurt Americans. But it's our only hope against inflation.
The Fed has raised its short-term benchmark fed funds rate six times this year to a range of 3.75% to 4%, and it’s expected to increase rates another half percentage point next week, with more to come next year.
Even so, the Fed said in September, the median forecast for its preferred consumer inflation gauge would still run at 3.1% next year as the economy slows from the effects of its rate hikes. That measure also tends to run cooler than the well-known consumer price index, which was 7.7% in October.
Will that cool inflation expectations?
Possibly, but “the risk of inflation becoming entrenched at higher levels is very, very real,” said John Leer, chief economist at Morning Consult, which monitors 12-month inflation expectations weekly. Its indicator, developed with the Cleveland Fed, eased off a peak above 8% in November but remains high at 7.64% as of Monday.
“So much of it is that inflation is on the mind, noticing small price increases, hyperaware,” Leer said. “People in economies with high inflation are better at predicting high inflation than those in low inflation economies because those people stop thinking about it.”
Even the ups and downs of gas prices have offered little relief. “It’s like pennies on the dollar, saving $5 or $6,” Blafford said. “They’re far from being accommodating to the regular guy.”
That’s especially true when grocery prices have soared 12.4% over the past year to October. With three kids, a dozen eggs that now cost $5 can disappear in a day, and a pack of bacon for $7.99 doesn’t stretch long either, because it's now in 14-ounce packages instead of a full pound, he noted.
The Fed hopes that if actual inflation recedes, people’s mindsets will reverse.
“But the emphasis is the time issue because it won’t be solved over the next 12 months,” said Steve Wyett, chief investment strategist at BOK Financial.
And like Powell said, the risk is that the longer inflation stays high, the greater chance higher inflation expectations will take hold.
If inflation expectations start to trend higher (rising for more than a couple of months), then the Fed may consider raising the fed funds rate as high as 6% or 7%, Wyett said. Right now, economists forecast Fed funds rate increases will stop around 5%.
That could further hurt financial markets, another drag on consumer psychology.
"It would be a real negative for bonds and stocks,” Wyett said.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at email@example.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.
This article originally appeared on USA TODAY: Inflation eases but consumers aren't convinced, making Fed job harder