Industry Study

Industry Study

2023 Inflation Study

Study Summary:

Inflation is up 7.1% annualized, and real average earnings dropped by 1.9% from November 2021 to November 2022. 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 7.1% in November 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. However, US CPI inflation came in better than expected, both for the headline (7.1%, an 0.1% MoM increase) and core (6.5%).

We are experiencing the highest inflation rates since 1982

The problem with indexes and abstract terms like inflation is that it can be hard to grasp their real-world significance. What does a 7.1% 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) hits a 40-year high

The Sticky-price consumer price index (CPI)—a weighted basket of items that typically changes relatively slowly—increased by 5.5 percent to 6.6% (on an annualized basis) in November, following a 5.5 percent increase in October. Many economists consider the core inflation index is a better predictor of future inflation than overall CPI, which is more volatile because these goods and services change less frequently. Compare the historical trend of the core CPI and flexible CPI, which includes a weighted basket of items that change much more frequently. Current inflation rates are not just a result of a spike in energy and food prices — as is often the case — core inflation rates have not been at this level since 1982.

Core inflation remains sticky

The sustained rate of core inflation and its contributions to overall inflation (CPI) likely indicate that high inflation rates are here to stay at least in the short and medium term.

Shelter inflation increased, food is at 10.6%, and energy prices dropped to 13.1%

Shelter inflation increased, and while home prices are starting to recede, rents don’t really come down. Food prices increased by 10.6 year over year in November 2022. That is one of the highest food inflation rates in 40 years, but it’s a drop from the 11.2% peak of September 2022, which in turn dropped from 11.4% in September. The overall inflation rate — the average cost of all products tracked by the CPI — dropped to 7.1%. Used cars and trucks dropped by 3.3 percentage points in November, making this the fifth consecutive month it drops.

The drop in used vehicle prices drove the CPI

Manheim Used Vehicle Value Index
Source: Cox Automotive; Chart: Axios Visuals

The dramatic drop in used car prices (40.5% inflation in January 2022 and -3.3% in October) moved the CPI number. The deflation of used car prices will accelerate as the backlog of repossessions starts, and Carvana dumps inventory to get solvent.

Housing inflation hits renters and low-income families the hardest

The cost of housing increased by 13.0% year over year, in August 2022 (latest data available), 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 7.5% (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 only slightly more than overall inflation (7.9% vs. 7.1% in October 2022). Anybody who has tried to rent an apartment in the real world knows that the cost of rent has increased by much more than 7.9% 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

November 2022 is the 20th 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 1.9 percentage points (seasonally adjusted) from November 2021 to November 2022. The change in real average hourly earnings combined with a drop of 0.3 percent in the average workweek resulted in a 3.0-percent decrease in real average weekly earnings over this period.

Real disposable income drops for the 7th consecutive month since March 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. On December 9 the Federal Reserve Bank estimated real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2022 is 3.2 percent. This is down from 4.0 percent on November 9th.

Add to this that the Federal Reserve is likely to continue compensating 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.

We expect high inflation to plateau at this level since it’s unlikely the Fed will pivot to a dovish policy until something breaks. However, the drop in home prices and auto vehicles is an indication the Fed is starting to get traction with inflation.

Key takeaways

  • 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 7.1%. Food prices increased by 10.6%. Used cars and trucks dropped by 3.3%, and energy costs have increased by 13.1%.
  • 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.
View Article Sources
  1. Consumer Price Index 1980 – 2022 – Federal Reserve
  2. CPI up to September 2022 – BLS
  3. Consumer Prices by Category – BLS
  4. Core sticky inflation – Federal Reserve
  5. Contributions to CPI – OECD
  6. Real disposable personal income per capita – Federal Reserve
  7. S&P Case-Shiller U.S. National Home Price Index – Federal Reserve
  8. U.S. Households Face $5,200 Inflation Tax – Bloomberg
  9. Consumer Price Index News Release – BLS
  10. National Rent Trend – Realtor