From sky high home prices to automobiles that cost more than twice what they did pre-COVID to increased costs for everything from groceries to haircuts, inflation has taken the fore in the economic outlook this decade.

In 2022, prices were rising at a 9% rate, the worst inflation rate since the hyperinflation of the late 1970s and early 1980s that prompted the Federal Reserve – at the time led by Paul Volcker – to undertake a shock therapy of double-digit interest rates.

This time around, the Federal Reserve has bumped rates from zero to 5.5%, but left the rate unchanged in their November meeting.

The overall inflation rate is now down to 3.2%.

So is the beast of inflation slayed? Has the much-hoped-for soft landing occurred, with a decline in inflation while avoiding a recession?

Not so fast, says Associate Professor of Economics Pedro Amaral.

Inflation is Falling, But Isn’t Dead. And the World Situation Remains Precarious.

“Inflation is still higher than before the COVID pandemic, and importantly, is still above the Fed’s target of 2%,” notes Amaral. “So the job is not finished. And much uncertainty remains ahead given the current geopolitical situation.”

First, it was Russia’s war in Ukraine that sent energy and commodity prices soaring in the first half of 2022. Now, the most brutal Arab-Israeli war since Israel became a nation in 1948 is adding uncertainty.

“So far, energy prices have not responded to the crisis in Israel and Gaza, but if the conflict extends to other parts of the Middle East, there is by no means a given,” notes Amaral, referencing fears that Hezbollah, a terrorist group with direct ties to Iran, may enter the conflict. Additionally, Iranian proxies have been attacking American targets around the world in recent months, raising fears of a wider conflict.

“Moreover, while the price of gas has dropped in the last few months, the prices of services have been pushing the consumer price index (CPI) up.”

Service inflation tends to peak later than goods inflation. That is because those who provide services – be they hairdressers or auto mechanics or dentists – must charge more to make ends meet. And the situation is particularly acute in California, where home and rent prices are stratospheric. Add to the mix higher minimum wages in California and many other states that put upward pressure on prices.

“While most economic projections call for an average inflation rate of 2.5% next year, which constitute further improvement, the Fed must remain vigilant,” says Amaral. “In any case, the market is now predicting the Fed is done raising interest rates. This, along with the news that the economy is slowing down, resulted in a rally in long-term bonds. Importantly for consumers, this brought about a modicum of relief in mortgage rates. So the news is good, but we are not out of the woods yet.”

Living in Times of Inflation

A decade ago, inflation was under 1% in many years.

Though home prices were already out of reach for many buyers in Los Angeles and Orange counties, the cost of everything else was well within check.

This cheery state of affairs was part of the Great Moderation – the Fed’s accomplishment of low inflation and relatively low unemployment that prompted many experts to contend that the harsher economic cycles of the past were obsolete in the new millennium.

(Read more about the Great Moderation in a 2016 article featuring Gabriela Best).

While interest rates might seem to the younger generations to be high, they are actually at only moderate levels historically.

The Taylor Rule – which holds that interest rates should equal the peak inflation rate of a given cycle – is far from being achieved.

And since prices themselves are unlikely to fall substantially, even if the rate of inflation declines (a situation known as disinflation, as opposed to deflation), living with higher prices is probably the name of the game for the foreseeable future. Particularly as wage growth has failed to keep pace with inflation for decades, a situation only exacerbated by the current cycle.

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