Choose Your Own Inflation

I wrote a short post about inflation last year (so far it’s holding up pretty well), but I wanted to revisit the topic because I came across the following really interesting chart (source).

This chart contains a lot of useful information but, like many data, it can be interpreted in a lot of different ways in order to support your priors. For example, more conservative folks like to point to these numbers and say that most of the items that are more subject to market forces (capitalism!) have been going down, while those that the government are involved in (socialism!) have been going up. On the other hand, other folks note that things that are manufactured have gone down relative to things that are more service-based. Or, perhaps, things that are important to us like medical services, education, food and housing have gone up more, and things that aren’t nearly as important like TVs, cellphone service, and household furnishings have gone down.

But there are two other aspects of this chart that I wanted to comment on. First, something that I think is often overlooked in the general discussions around inflation is that there is not “one” inflation rate for everyone. Yes, there is one overall inflation rate calculated for your country (although, even with that, areas of the country can vary somewhat). But just like personal finance is “personal”, so is inflation. For example, let’s take a look at some of the items in red (the items that have increased more than the overall inflation rate in this period) in the context of my family (you could do the same for your family).

• Hospital Services: We needed this once in those ~22 years.
• College Tuition and Fees: None for my wife and I; undergraduate education for our daughter (but, crucially, only four years – not all 22 in this chart)
• Medical Care Services: We’ve used some, but not a lot
• Childcare and Nursery School: None
• Food and Beverages: Yes, we do eat and drink. But we don’t eat out very often and we mostly drink tap water, so our increase has been lower.
• Housing: Our home is paid for. As the value of our home has increased, our property tax and home insurance has increased, so some impact here, but not a lot.

So, for us, the items in red have had a smaller impact than they might for others (or for the overall inflation rate). In other words, our personal inflation rate has been lower. This is especially true when you take into consideration Nick Magguilli’s point that if you are a saver, then your income can actually go up less than inflation and you still won’t really be affected by it. And, the higher your savings rate, the less affected you are. (Which, of course, is another example of those who have money have an advantage over those who don’t.)

But there’s also a second important point I wanted to make, which is the very chart itself. The design of the chart ends up manipulating us. Now, to be clear, I’m not saying that there’s anything technically wrong with the chart, or even that the creator of the chart was necessarily trying to manipulate us. Rather, the manipulation is due to the quirk of how humans think. As I’ve said before, humans are generally linear thinkers and we are horrible at comprehending exponential growth. This is why so many people are shocked by the growth of investments over time (due to compound interest), why they overestimate how good of an investment their primary residence is (due to compound interest), and why they underestimate how much carrying a balance on their high-interest-rate credit card is costing them (due to, you guessed it, compound interest). Which means that when a chart like this is constructed, looking at cumulative inflation over a ~22 year period, it plays into our cognitive difficulties understanding compounding.

To combat that a bit, let’s take a look at that chart as a table, but looking at annual inflation rates instead of cumulative (compounded) rates.

This, I think, has a very different impact on most people compared to the chart. Now, no doubt, an annualized increase of 5.56% in hospital services over this period is not good, but I also think it has a different emotional impact than a “220% increase.” And I think it’s particularly important to note the three rows that are highlighted in different colors. For this ~22 year period, everything below the blue line of Average Hourly Wages has actually decreased in terms of cost/increased in terms of affordability (again, for the average person, your personal wage increase will vary). And the overall annual inflation rate for this period of 2.62% is actually significantly lower than the average inflation since WWII (3.67%).

Again, none of this is to say that inflation isn’t something to be concerned about, and that certainly we need to see what we can do to rein in the costs of healthcare and higher education. It’s also important to realize that inflation most affects the people who make the least, the ones who are barely making it, whereas much of the angst and political commentary around inflation are from those of us who, in reality, can handle it just fine. In some ways, I think this is much like the old Choose Your Own Adventure books, except you are choosing your own inflation. Overall inflation isn’t necessarily your personal inflation and, in many cases, you have some control over your personal inflation. And you can choose how you decide to view inflation numbers, either looking at it over 22 years and saying, “OMG!”, or realizing that our inability to understand exponential growth/compound interest makes it more useful to look at that table showing annual growth instead of the chart (and put it in the context of both wage growth and historical inflation).