Why the Cost of Living Only Goes One Way (And Why Inflation Isn't What You Think It Is)

There's a misconception about inflation that almost everyone has, and it quietly costs them money.

When the news says "inflation is coming down," most people think "prices are coming down." But the truth is they aren't. They're going up slower. That distinction is the difference between thinking the economy is recovering and understanding that the new prices are permanent.

Because in modern America, prices almost never come back down, Not after the dot-com bust. Not after 2008. Not even after COVID. Once something costs more, it stays costing more.Let me show you what I mean.

This is the cost of living in America over the last 54 years. Five decades, a dozen presidents, wars, crashes, recessions, and technological revolutions. Through all of it, the line only moves in one direction.

Up.

The thing most people get wrong about inflation

The previously mentioned mistake is a natural one. The word inflation feels like a thing, like prices going up. So if inflation falls, prices must be falling too. Right? Wrong.

See, Inflation isn't simply a price rather it can be seen as speed. Specifically, it's the rate at which prices are rising. When inflation drops from 7% to 3%, prices are still going up, just slower. The gallon of milk doesn't reverse. It just rises less quickly.

Watch this graph. This is the inflation rate. It spikes in the 70s, crashes in the 80s, stays low through the 2010s, spikes again in 2021-2022, comes back down. It moves up and down constantly.

Now compare it to the first graph. The first graph keeps going up. This one goes up and down. They look completely different, but they're measuring the same prices. The first one shows you where prices are. The second one shows you how fast they're changing. The first one is showing distance traveled, and the second one is showing speed. 

The asymmetry that runs the whole game

Go back to the cost of living chart. Find a place where the line drops for any meaningful stretch. You won't. Across 54 years, the longest sustained decline is basically zero. There's a tiny dip around 2009 during the worst of the financial crisis, and that's it.

Now look at the inflation rate chart again. In 2009, inflation actually went negative briefly. We had deflation. And even then, the cost of living chart barely flinched. This is one of the most important features of the modern economy and almost nobody talks about it. Prices are sticky downwards. They go up easily, and they almost never come down.

• Wages don't fall easily. Workers won't accept pay cuts, so businesses can't easily lower manufacturing prices.

• Long-term contracts lock in higher prices. Rent, utilities, insurance are things that once they go up, they rarely come down.

• Once consumers accept a higher price, businesses have no incentive to lower it.

• The Federal Reserve actively targets 2% inflation as a goal. They don't want prices to fall.

  
  

That last one is especially important because the Fed itself wants prices to rise, so inflation is actually a policy of the system rather than an accident or failure.

Why the Fed wants prices to go up

This sounds insane the first time you hear it. Why would anyone want things to get more expensive?

Because the alternative is worse. When prices fall, which is what economists call deflation, people delay purchases. Why buy a couch today if it'll be cheaper next month? Businesses see demand drop and cut production. Workers get laid off. Those workers spend less, which means prices fall more, which means more people delay purchases. It really just creates a snowball effect. 

The Great Depression was a deflationary spiral. Prices fell about 25% between 1929 and 1933, and so did wages and employment. Japan spent the 1990s and 2000s stuck in mild deflation and economists call it "the lost decades." So central banks decided that a little inflation every year is the safest path. Two percent is the magic number. It doesn't sound like much, but it compounds.

At 2% annual inflation, prices double every 35 years, and over 50 years, the cost of everything nearly triples. The dollar you earn at 25 buys about a half of what it bought your parents at the same age. That's the price of stability. We've decided as a society that a slow, steady erosion of purchasing power is better than the alternative.

So if everything costs more, are we poorer?

Saying yes seems intuitive, but the real answer is not necessarily, because incomes will also eventually rise.

Median household income has grown over 50 years even after adjusting for inflation, going from around $66,000 in 1970 to about $103,000 today in real 2023 dollars. So in theory, we should be keeping up, but instead it feels like we are lagging behind everyday.

Why? Because real wage growth, which is the growth in what your paycheck actually buys after inflation, bounces around constantly. Some years it's positive, and some years it's deeply negative. In 2022, real wages fell more than 3%, In 2008, they fell over 3%, and In the early 1980s, they fell for years. The reason why everything seems so expensive all the time is that prices are sticky downward, but wages are not most of the time.

When inflation spikes, your paycheck buys less immediately, but when inflation drops, your paycheck recovers slowly over years, if at all. This is also why a "good" year for inflation can still feel terrible. If inflation is 3% and your raise is 2%, you get poorer, while the Fed pats itself on the back for a job well done. 

The thing nobody warns you about

There's another piece of this that doesn't get enough attention. Even when overall inflation is low, the things you actually have to buy keep getting more expensive, usually faster than the headline number.

Healthcare spending per person has more than doubled since 2000. College tuition is even worse, along with Childcare and Housing. The big-ticket items that define middle-class life have outpaced wage growth for decades.

Meanwhile, the things that have actually gotten cheaper, like TVs, clothes, electronics, and plane tickets, are things you buy occasionally. They feel like deals, but they aren’t the recurring expenses that will free up your monthly budget. So you end up in a strange place where the news tells you inflation is low, your TV is cheap, and your rent ate half your paycheck.

What I take away from this

A few things.

The cost of living chart isn't a graph of failure. It's a graph of policy. We chose this. Every Federal Reserve meeting and every government budget is calibrated around the idea that prices should rise by about 2% a year.

"Inflation came down" doesn't mean prices came down. It means they're rising more slowly. Get used to the new normal, because there is no going back to the old one. The 2021-2022 spike permanently reset what things cost, and the baseline it set will be perpetually increasing.

Whether this system is fair is a different question. But if you're going to live inside it, you should at least know how it works.

The line goes up by design and your money buys less by design.

Next post: Why Federal Spending Never Goes Back Down