September’s inflation numbers came out this week, and they were higher than anyone wanted or expected. The consumer price index shows that the cost of living rose by 3.7% over the past year. Then yesterday, the producer price index came out — think of this as measuring the inflation that producers have to deal with — and this upstream measure of inflation was also higher than anyone wanted or expected. I wrote about the consumer inflation numbers when they came out. If you missed that, you can catch up here:
Now it’s time for The Professor Is In, where my producer Augusta Chapman brings me questions from the audience. Think of it like office hours. My door’s open, come on in.
Augusta brought me one question that many of you asked. Prices feel like they’ve gone up way more than 3.7%. How can that be the official number? Isn’t it way too low?
I believe this number
Measuring the cost of living is hard. You might think we’d do it by simply counting what everyone buys one month and then doing it again the next month (and the next). But what about when strawberries go out of season? Or the old iPhone gets replaced? And how do you deal with prices that rise every winter? The consumer price index handles all of that, using the best methods available. For the average American consumer, the cost of living rose 3.7%.
You may not be the average American. Most of us aren’t, and your own rate depends on where you are and what you buy. Augusta doesn’t own a car, so skyrocketing gas prices don’t affect her directly. Her inflation rate is probably a bit lower. I live in the suburbs in Michigan, where we drive everywhere, so mine is probably a little higher. As a guess, most people are experiencing personal inflation rates somewhere between 3% and 4½%.
But why does it feel so much higher than that?
Three reasons.
Reason #1: Six-foot-tall prices
There are some prices that whisper and some prices that shout. Gas prices are, quite literally, six feet tall, and you drive past them every day. People’s sense of the economy rises and falls with the price at the pump.
There are things I spend more on than gas. One is health insurance. I honestly don’t track how much that costs — it’s a deduction that comes out of my paycheck each pay period. And I know I should check my pay stub, but I don’t. (Don’t tell my employer.)
Reason #2: Loss aversion
Behavioral economists have taught us that the sting of a loss is sharper than the joy of a gain. A rising price makes you feel like you’re getting ripped off, but a falling price just slides by. TVs have never been cheaper, or better, and they used to be something you had to save up for. Nobody throws a parade for that.
Reason #3: The $7.26 cappuccino
The third thing that makes inflation feel so high is something I’ve fallen for myself. Survey researchers call it telescoping.
I was recently at the Detroit airport. I went to the airport Starbucks and ordered a cappuccino. It cost me $7.26! That’s about $10 Australian. My first thought was: doesn’t Starbucks cost $3.50? Wow, coffee has doubled in the past year.
It hasn’t, though. My memory of a $3.50 cappuccino is real, but it doesn’t come with a date attached. It might be from 2022. Or from 2015.
Survey researchers are very familiar with this problem. Ask people about prices over the past year and they’ll reach for a memory without too much concern about whether it fell within a twelve-month window. History casts a long shadow in our memories, and sometimes it feels more recent than it is.
So when the official statistic doesn’t match your gut, it’s a good time to check the timestamp.
More on the September inflation report
Other questions Augusta asked me:
The producer price index is up 6.3% over the year. How is that connected to consumer inflation? Is this a preview?
Does diesel really matter so much for consumer prices?
What’s going on with the changes in how the government calculates inflation?
Finally, what happened to all that tariff gloom?
Augusta’s last question: There were so many predictions of dire economic consequences when tariffs were first announced. What happened? Shouldn’t inflation be at 7% or 10%?
What I say now — and what I said then — is that a lot of public commentary about tariffs was misinformed (on both sides). There’s some simple arithmetic here. We’re a remarkably closed economy. We buy a lot from elsewhere, but it’s Michiganders importing from Ohio (or everyone importing from California), rather than from abroad. In total, around one-tenth of what we spend goes on imports.
Apply a 20% Liberation Day tariff, assume it’s all passed on, and the cost of living rises roughly 0.1 × 20% = 2%. Reduced competition from abroad may also lead domestic businesses to raise their prices on American-made goods a bit more. Spread these price changes over a year or two, and inflation runs maybe 1 or 2 points higher than it otherwise would.
Tariffs are problematic for a number of reasons, but inflation’s not the main one. Or not in the ordinary sense. The real problem is that they reduce real incomes. That’s because tariffs are a supply shock. With a more typical demand-driven inflation, demand rises, your boss charges higher prices, profits rise, and competition for workers heats up. Ideally wages catch up within a year or two.
With tariffs, your boss’s costs rise, and their profitability falls. A price rise restores their profitability, but the business is not better off than it was before, and so there’s no reason to pay higher wages. As a result, that raise never comes. Being 2% poorer for a year is a bad thing, but being 2% poorer for a whole career is far worse.
Watch the full episode for the rest.