Inflation is up 8.3% annualized. What’s worse is real hourly wages for American workers dropped by 2.4% in the last 12 months. The average U.S. household spent an extra $5,200 this year because of inflation. This “inflation tax” has hit low-income households the hardest. Households with incomes in the bottom 20% got a 15.6% wage cut because of inflation.
Unless you have been hunkered down in a doomsday bunker in New Zealand for the last year, you know the United States is dealing with a huge inflation problem. But, more importantly, so does your wallet.
U.S.consumers haven’t seen inflation rates like this in decades. The percentage change in the Consumer Price Index (CPI) for the last 12 months (a.k.a inflation) for all items was 8.5% in July 2022. You would have to go back to 1982 to see higher inflation rates. I was two years old, so my recollection is a little fuzzy.
We are experiencing the highest inflation rates since 1981
The problem with indexes and abstract terms like inflation is that it can be hard to grasp their real-world significance. What does an 8.3% inflation rate mean to the average consumer? How does it affect the poorest and wealthiest members of society?
Trying to answer these questions and make sense of an abstract measure like inflation requires making some assumptions. One way to do it is to ask 24,000 consumers about their spending habits to build a basket of consumer goods and services and track price changes. That is, in a nutshell, how the Consumer Price Index (CPI) works.
Inflation measures the price changes of the goods and services tracked by the CPI. But, of course, the prices of goods don’t change in tandem. As a result, there is a lot of variability in inflation across goods and services tracked by the Consumer Price Index.
Core inflation (aka sticky-price index) hit a new high
Although the overall annualized inflation rate dropped in August 2022, sticky-price inflation, which excludes energy and food, hit a new high of 6.3%.
The Atlanta Fed’s sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—increased 6.3 percent (on an annualized basis) in August, following a 5.4 percent increase in July.
Food prices increased by 11.4%, energy prices are up by 23.8%
Food prices increased by 11.4% year over year in August 2022, which is higher than the 10.9% in July 2022. However, it is also the smallest month-to-month increase in food prices since December 2021. The overall inflation rate — the average cost of all products tracked by the CPI — dropped to 8.3%, and energy costs are also down from 32.9% to 23.8%. Used cars and trucks are experiencing a 7.8% year-over-year inflation rate, which is a significant increase from last month’s 6.6% inflation rate.
Housing inflation hits renters and low-income families the hardest
The cost of housing increased by 19.2% year over year, in January 2022, according to the Case-Shiller National Home Price Index. This makes it harder for renters who want to become first-time homebuyers. Rental inflation according to the Bureau of Labor Statistics, is much lower: at 5.8% (June 2022), but, as we discuss below, this is an artifact of the method the BLS uses to measure rental inflation.
Renters tend to skew toward the lower incomes. According to data from the Federal Reserve about six-in-ten Americans in the lowest income quartile (61%) rented their homes, as did 88% of people with net worths below the 25th percentile. In other words, households with lower incomes are more likely to be renters. The Federal Reserve study found that only 10.5% of people in the top income quartile were renters.
CPI understates rent inflation by 300% to 400%
According to the CPI data published by the Bureau of Labor Statistics, renting costs are rising but significantly below the average inflation rate (5.7% vs 8.5% in July 2022). Anybody who has tried to rent an apartment in the real world knows that the cost rentals has increased by much more than 5.7% in the last year.
We compared the inflation rate reported by BLS with the real-world data collected by Realtor, Redfin, and ApartmentList and found that the BLS’s CPI is three to four times lower. The reason for this is obvious when you consider how the CPI collects its data.
Why does CPI understate rent inflation?
The short answer is that the CPI for rent is a lagging indicator that doesn’t reflect current changes in rental prices. As mentioned above, the Bureau of Labor Statistics calculates rent prices using a survey. This survey asks renters “What is the rental charge to your household for this unit, including any extra charges for garage and parking facilities? Do not include direct payments by local, state or federal agencies. What period of time does this cover?”
The issue here is that the BLS is asking what renters currently pay, not what the landlord would charge if new tenants were to move into the house. For this reason, CPI understates rising rents, particularly in times when prices are rising quickly.
Inflation will cost the average family $5,241 ($433 a month) this year
On average, this means that each U.S. household has to spend an additional $5,200 this year to buy the same goods and services it purchased last year, according to estimates by Bloomberg Economics.
The inflation tax, of course, increases for wealthier consumers because they, well, spend more. However, the poorer consumers feel the cost of inflation much more because it represents a larger percentage of their incomes, and they have less wriggle room to absorb changes in prices.
We looked at the median household income for each quintile (chunks of 20% of the population), and this is what inflation costs each group as a percentage of their median income.
Inflation gave low-income families a 15% pay cut
Households with incomes in the bottom 20% got a 15.6% wage cut because of inflation. It’s worse than that. Lower-income families spend a bigger chunk of their income on basic necessities, such as food, housing, and gas, which are often significant contributors to high inflation.
Medium and high-income households may have to cut back on eating out or vacations to offset the cost of inflation, but low-income families often have to cut back on basics, such as food and medical care.
Some households were indeed able to build up their savings during the pandemic, and many workers are seeing increases in their wages, which does help soften the blow of inflation. However, this is not the reality for most lower-income households who couldn’t work remotely and lost their jobs during the lockdowns.
In any case, inflation will cause savings to run out faster, which will push more workers into the labor force and eventually stunt wage growth.
Yes, it’s pretty bleak, but nobody said high inflation was fun. Unfortunately, the medicine for inflation is even less fun. It involves increasing interest rates and reducing spending in welfare programs, which disproportionally hurts lower- and middle-income households.
Despite what you may have heard, wages are not really going up
June 2022 is the 15th consecutive month real average hourly earnings have decreased; the last increase was 1.7 percent in March 2021.
This may surprise you because we hear a lot about how workers’ wages are growing faster than at any point since 2001. That is true, but only if you ignore inflation.
Real average hourly earnings—that is, earnings that have been adjusted for changes in consumer prices — decreased by 3.6 percentage points (seasonally adjusted) from June 2021 to June 2022. The change in real average hourly earnings combined with a drop of 0.9 percent in the average workweek resulted in a 4.4-percent decrease in real average weekly earnings over this period.
Real disposable income dropped by 5.6% in the last quarter of 2021
Inflation has erased all income gains in the last year.
Disposable income is after-tax income. It’s the amount that U.S. residents have left to spend or save after they pay taxes. The formula is simple: personal income minus personal current taxes.
Real disposable income is still historically high, but it is dropping, not increasing, despite the “rise” in average wages.
Rapid Fed rate hikes and a slower growth in GDP could trigger stagflation
The quarterly real GDP growth is slowing down. The Federal Reserve Bank is forecasting that GDP will drop to 1.4% in the third quarter of 2022. Add to this that the Federal Reserve is likely to compensate for its policy missteps with further rate increases, and you have all the ingredients you need for a stagflation (i.e. high inflation, high unemployment, and slow or negative economic growth). Historically, rapid rate increases usually result in a recession.
- The average U.S. household has to spend an extra $5,200 this year because of inflation.
- Inflation gave the poorest households (bottom 20%) a 15.6% pay cut.
- Overall inflation increased by 8.3%. Food prices increased by 11.4%. Used cars and trucks are up by 7.8%, and energy costs have increased by 23.8%.
- Inflation will cause excess savings to run out faster, which may push more workers into the labor force and slow down the increase in wages, which is currently softening the blow of inflation.
Andrew is the Content Director for SuperMoney, a Certified Financial Planner®, and a Certified Personal Finance Counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.