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Physician Finances

Your Inflation Rate Is Not My Inflation Rate

Inflation is the increase in the cost of goods and services over time. A little inflation is a good thing and indicates adequate consumer demand and a healthy, growing economy. But too high of an inflation rate can be a sign of an unhealthy economy. The biggest danger of inflation is when the inflation rate is higher than the simultaneous increase in wages – in this case, a person’s net purchasing power decreases, meaning that the person is unable to afford as many goods and services as in they could in the past.

To understand inflation, you first have to be able to measure it. In the U.S., the most commonly used measurement of inflation in the consumer price index (CPI), which is reported monthly by the U.S. Bureau of Labor Statistics. When most people talk about the CPI, they are talking about the “Consumer price index for all urban consumers: US city average, all expenditures“. There are some caveats about this measure, however. It only includes people living in urban and metropolitan areas. Although this accounts for a little over 90% of the U.S. population, it does not include rural residents, farming families, and members of the military – the inflation rate for these latter groups could be higher or lower than the inflation rate for urban residents. The CPI is reported in three ways: (1) as an index compared to the benchmark of prices during the period of 1982-1984, (2) as the percent change in CPI over the past 1-month and (3) as the percent change in the CPI over the past 12-months. The benchmark of prices in 1982-1984 is defined as an index of 100 and as prices go up, that index goes up. The index in February 2023 was 300.840 and the index in February 2024 was 310.326.

The percent change in CPI is also reported as “unadjusted”, and “seasonally-adjusted”. This is important because the price of some goods and services normally varies by season. For example, the price of fruit and vegetables normally goes down in the summer when these foods are freshly harvested whereas the price of gasoline normally goes up in the summer when vacation travel increases. The seasonally-adjusted CPI is generally preferred over the unadjusted CPI when looking at the 1-month change in CPI. The 12-month CPI does not require seasonal adjustment since it encompasses all four seasons of the past year.

In addition, there can be significant geographical differences in inflation depending on where in the United States a person lives. For example, for the 12-months between February 2023 and February 2024, the CPI increased by 3.2% for the U.S. in total. But the CPI increase in specific regions varied: northeast 2.4%, south 3.7%, west 3.2%, and midwest 2.8%. Even more specifically, the 12-month CPI increase for Cincinnati was only 1.1%, Milwaukee 1.8%, San Francisco 2.4%, Miami 4.9%, and Dallas a whopping 5.3%.

The CPI can be subdivided into different categories of goods and services and there can be tremendous variation in the 12-month change in prices of these categories. The graph below shows the 12-month CPI change for selected goods and services and ranges from automobile insurance that increased 20.6% to health insurance that decreased 19.7%. The average CPI for all goods and services was 3.2% (red bar below).

In February 2024, the 12-month increase in average hourly wages was 4.3% (green bar above). This means that the overall inflation rate (3.2%) is lower than the increase in wages, indicating that the average worker can buy more stuff with their earnings than they could a year ago. For any category of goods and services with a percent change in CPI less than the percent change in wages of 4.3%, the average worker can buy more of those goods and services. For any category with a percent change greater than 4.3%, the average worker could buy less of it. Therefore, even though the CPI for food cooked at home rose by 2.2% in February 2024, the average worker could buy more food at the grocery store with his or her paycheck whereas that worker could buy fewer restaurant meals, which increased by 4.5%. Inflation is often said to be hardest on retirees with fixed incomes. But this can be misleading because fixed incomes are not always really fixed. For example, in 2023, Social Security checks increased by 8.7% in order to keep up with increases in the cost of living.

Your personal inflation rate

How inflation affects you personally depends on how much your income increases each year relative to the increase in the CPI. It also depends on the increases in the CPI of individual things that you spend your money on and where in the U.S. you live.

For me personally, I live in the midwest where the CPI increased less than for the U.S. in general. I also do not spend much on goods and services that have had a large increase in price: my house is paid off so housing costs are negligible, I rarely eat in restaurants, and I don’t smoke cigarettes. What I do spend money on are goods and services that have decreased in price: I heat my house with natural gas, I recently booked airline tickets for 3 trips, I rented a car for one of those trips, and I just bought a new computer to replace my 10-year old laptop. So, my personal inflation rate is quite low and overall, I am paying less for the goods and services that I buy than I did a year ago. The bottom line is that my personal economy is currently not just good, it is outstanding! On the other hand, a smoker who lives in Texas, eats at restaurants a lot, and rents an apartment is facing a relatively poor personal economy (public service announcement: if you are a smoker, you can make your personal economy a lot better this year by quitting).

The aggregated CPI is very useful from a macroeconomic standpoint for government policy makers looking at the country as a whole. But it is less useful for individuals whose spending patterns and geographic location can vary considerably compared to the average. Making an annual household budget every year and then incorporating data from the Bureau of Labor Statistics CPI reports into that budget is a great way to ensure that your personal inflation rate does not unexpectedly bite into your checking account mid-year

The cycles of life

Our lives go through a series of cycles. We start in our education years, followed by our early working years, our child-raising years, our wealth-accumulation years, and finally our retirement years. Inflation affects us differently at each of these stages. It also affects us by the expenditure choices that we make during each of these stages. The way to make your personal economy beat inflation is to make those expenditure choices wisely: when the CPI for eating at restaurants goes up, cook your meals at home. When the CPI for airline travel goes down, book a vacation. Much of our personal inflation rate is ultimately under our own control.

March 13, 2024

By James Allen, MD

I am a Professor Emeritus of Internal Medicine at the Ohio State University and former Medical Director of Ohio State University East Hospital