Inflation: Official Rate vs. Observed Rate

[Aerides]

Inflation is and will always be primarily a problem for low income individuals as they are least able to adjust their budgets other than otherwise just dropping items.

I don't think it's low income, but most income. If gas and groceries are each costing the average family an extra $20 a week, that's over $2k per year - unplanned. Probably more for families with 3-4 kids, and with both parents commuting, maybe a teenager or two also driving.

When I was working, I had a long commute, and I remember in the height of 2008 prices, with gas and tolls, it cost me $20 per day round trip to go to the office.

 

[2177V]

I disagree.


I'm definitely not low income, but I already have my budget cut very lean with nowhere left to cut, and I have a very healthy stash, but inflation has devalued my savings by multiple years of retirement in the last year alone. You can't always expect your investments to outgain inflation, especially with stocks so overvalued and a big correction still on the horizon. Plus, people typically invest more conservatively as they get older so they don't take such a massive hit to their portfolios when the markets drop and can take well over a decade to recover as inflation continues to increase prices.

If someone is low income and still working, they will likely be getting raises to help compensate for inflation. If you have a massive savings, it's just taken a big hit in devaluation, and even if you are still working and get a raise, that's not going to make up for the massive devaluation of your current savings.

I also disagree with Running Man since he stated that only when the stock market is affected will most people on this forum will be affected. Inflation causes prices to rise which mean company has to pay higher wages. To avoid profit margin from being squeezed by higher wages, the companies has to raise prices which fan the flamed of inflation even more. This may cause layoffs which decreases demand which also squeeze profit margins. Why do you think the FED’s target of inflation is 2%? This is because they know how high inflation adversely impacts the economy. Inflation can cause instability and instability is not a good thing for the stock market.

The FED WILL raise interest rates and higher interest rates will cause the stock market to decline which will affect most people on this forum. This is why I reallocate some of my stock market money into income producing properties to reduce my exposure in the stock market. Having more real estate has been a good thing for me since real estate prices has increased significantly due to inflation.

 

[MichaelB]

The biggest losers from an increase in the inflation rate are people holding fixed rate bonds and retired people with pension income that is not inflation indexed. The purchasing power of their pensions and bonds suffer permanent loss of value. Annuities also lose purchasing power.

The issuers of fixed income and providers of pensions, primaritly the US govt, state gov’ts, and large corporations, benefit because their incomes rise with inflation but their debt obligations remain constant. People holding fixed rate mortgages also benefit disproportionately, as the value of the property rises with inflation while the mortgage remains flat.

Employed people tend to stay even with inflation over time, as nominal wages rise with inflation. Low income working class have mixed results. Starting wages have risen sharply over the past half year, but over the past 3-4 decades have lost ground to inflation. Right now it looks as if the bottom decile of hourly workers is enjoying real wage growth that may stick.

Over the past decade inflation has been seen as too low with the threat of deflation always present. Now inflation is too high. We seem to never be satisfied with what we have.

 

[Running_Man]

Some of the inflation might be delayed. For example, rental costs are shooting up but until more rental agreements are re-signed next year rental costs in 2021 I suspect are only slightly up when compared to 2020 when the "spot rate" of rents clearly shows that costs are rising rapidly. It will just show up in CPI next year.

Rents do not show up in CPI

 

[2177V]

The greatest threat to retirees with a large stock/bond portfolio is when the market returns are less than the inflationary rate. This results in a net loss. What good is a 5% market return on your portfolio when inflation is 6%?

This has happened in the past when you compared the S&P 500 performance and the inflationary rates. The light blue line is the gross S&P500 performance. The blue bars represents inflation. The red line represents S&P500 performance minus inflation which has gone negative three times in 1910's, 1970's, 2000's. Since most people have bonds, the situation can worsen since this assumes everyone has the performance of the SP500.

In addition, I always believed that inflation can benefit the federal government. This is because when inflation rises, wages have to rise. When wages rise, taxes rise due to higher income and this happens without the political backlash of a tax increase. The federal government already has a large debt due to the stimulus. Part of that debt will be paid down when inflation rises which will ultimately increase tax revenues. This explains why the federal government is in no rush to increase taxes to pay for the stimulus. It is because they do not have to. Inflation is a stealth tax increase.

 

[Figaro]

I just wonder why no one complained about "inflation" the last time gasoline prices were high around >$4 gallon through most of the country.

Personally my own CPI has not changed too much year on year. On groceries the same sales are happening - you just need to wait for a good price. For instance ground beef prices just crashed to the $2/lb range. Steak prices have flattened out too. It depends on where you buy your food. The Kroger affiliated store has tbonesteaks for $12/lb. I go to a different store and it's $6/lb. Shop at different places and you'll be fine eh?

The biggest variable for me is property taxes. I'm hoping that we have a real estate crash so my bill doesn't go up.

 

[Running_Man]

My point was the observed rate of inflation on say the 100 million people in the United States with average household income under $41,000 is far greater than anything that forum members on average are worried about or have to deal with. Gas, actual rent, food, utilities and used car purchases make up the bulk of their expenditures.

 

[2177V]

I just wonder why no one complained about "inflation"

The biggest variable for me is property taxes. I'm hoping that we have a real estate crash so my bill doesn't go up.

Good luck with your property tax not going up.

In California, Prop 13 was passed by a vote by California residents which restricted the property tax to be 1% of the property value. I had a licensed appraiser provided certain value of my house with documentation....but their own county appraiser provided a higher value without documentation. The county tax collector used the higher value by the county appraiser and rejected the documentation from the licensed appraiser.

They also added twenty (20) "fees" to the property tax bill and claimed the fees that comes with my property tax bill are NOT a property tax and therefore are excluded from the 1% Prop 13.

Example of the fees: Transportation fee, Maintenance fees, Wastewater fees, parks fees, bond payments (so the local government can live beyond their means), etc, etc, etc


I will not be surprised if they added an "inflation" fee to my property tax.

 

[CaptTom]

I just wonder why no one complained about "inflation" the last time gasoline prices were high around >$4 gallon through most of the country....

The biggest variable for me is property taxes. I'm hoping that we have a real estate crash so my bill doesn't go up.

I was pretty unhappy about $4/G gas! If you want to feel pain, try buying boat fuel at a marina!

The problem with property taxes is they just divide the municipal budget by the total valuation. In theory, if the total goes down, the mil rate goes up. Likewise if lots of folks buy new homes, and the average value goes up more than your individual home does, your tax should come down. Of course that's in theory. In practice there are more variables.

But I wouldn't count on a real estate crash resulting in lower property taxes.

 

[JT90505]

They also added twenty (20) "fees" to the property tax bill and claimed the fees that comes with my property tax bill are NOT a property tax and therefore are excluded from the 1% Prop 13.

I will not be surprised if they added an "inflation" fee to my property tax.

sigh.

CA Prop 218, passed in 1996, eliminated the ability of local governments to levy special fees and assessments collected on the property tax bill without voter approval. The only way you would be surprised by an inflation (or any other) fee or assessment on your property tax bill was if you did not pay any attention to elections.

How property taxes in CA are calculated is fairly straightforward and very favorable to homeowners. "California property taxes are based on the purchase price of the property. So when you buy a home, the assessed value is equal to the purchase price. From there, the assessed value increases every year according to the rate of inflation, which is the change in the California Consumer Price Index. Remember, there's a 2% cap on these increases." In deflationary years your property tax is reduced.

Despite the clarity on how a home is valued for property taxes, I am fairly certain if I contacted enough licensed assessors and let them know I felt my property assessment was too high, there would be a fair number who would be happy to take my money and deliver a lower number.

Due to props 13 and 218 CA property taxes are significantly lower than the national average, approximately 0.73% vs. 1.07%. So, for property owners anyway (and especially long term property owners), the whining about high CA taxes is significantly offset by a lower property tax.

 

[Amethyst]

This, in fact, caused my retired Dad to find a job well into his 60's. The union pension he'd paid into since the 1930's, wasn't COLA'd, and his SS raises and CD interest didn't make up the difference.

The biggest losers from an increase in the inflation rate are people holding fixed rate bonds and retired people with pension income that is not inflation indexed. .

 

[2177V]

I was pretty unhappy about $4/G gas! If you want to feel pain, try buying boat fuel at a marina!

But I wouldn't count on a real estate crash resulting in lower property taxes.

I would LOVE to pay $4 a gal for gas because it is $5 a gal for gas in California.

Property taxes only go up. When the housing prices crashed, the local government in California require citizens to prove that the value of their specific house has gone down in order for the government to re-assess the value of the house. If the government do reduce the value of the properties, it would only be by a token amount.

 

[2177V]

Believe it or not…there is no yearly property tax bill in China. Property taxes are only paid during the time it is sold. However, China is thinking about a yearly property tax because there are widespread speculation in housing and a yearly property tax bill proposal is intended to cool off the real estate market. When I informed Chinese citizens about the yearly property tax bill that I have to pay they responded “what do they do with all that money?” This is because the local governments in China get most of the revenues from sales taxes and taxes on gasoline.

 

[Markola]

The biggest losers from an increase in the inflation rate are people holding fixed rate bonds and retired people with pension income that is not inflation indexed. The purchasing power of their pensions and bonds suffer permanent loss of value. Annuities also lose purchasing power.

The issuers of fixed income and providers of pensions, primaritly the US govt, state gov’ts, and large corporations, benefit because their incomes rise with inflation but their debt obligations remain constant. People holding fixed rate mortgages also benefit disproportionately, as the value of the property rises with inflation while the mortgage remains flat.

Employed people tend to stay even with inflation over time, as nominal wages rise with inflation. Low income working class have mixed results. Starting wages have risen sharply over the past half year, but over the past 3-4 decades have lost ground to inflation. Right now it looks as if the bottom decile of hourly workers is enjoying real wage growth that may stick.

Over the past decade inflation has been seen as too low with the threat of deflation always present. Now inflation is too high. We seem to never be satisfied with what we have.

Excellent. I was a child in the 1970s, so I have not really experienced sustained, severe inflation. This is good breakdown of some of the practical effects.

You mentioned holders of fixed rate bonds being exposed. I hope bond index fund holders, while exposed, will see growing yields over time and, after the inflation rate eventually declines, even enjoy a few years on the back tail with their relatively high yielding fixed income allocation.

 

[Amethyst]

People most certainly did complain, and blamed the President too, just like today.

I propose that social media hadn't yet caught on to the extent they have nowadays, so there were fewer venues to complain and foment conspiracies.

I just wonder why no one complained about "inflation" the last time gasoline prices were high around >$4 gallon through most of the country.

.

 

[2177V]

People holding fixed rate mortgages also benefit disproportionately, as the value of the property rises with inflation while the mortgage remains flat.

I agree. I was in the real estate business as my second job on the weekends (my day job was an engineer). As a licensed real estate agent, I was aware that people with a 30 year fixed mortgage can celebrate because high inflation will never change their fixed monthly payments. Inflation makes the fixed monthly payments easier to pay since their wages rise.

I really believe we will have around 5 or 6% inflation but i do not think we will have double digit inflation. This is because the FED will raise interest rates which affects liquidity. This is how we solved the double digit inflation in the 1970's. However, the FED also knows that raising interest rates will reduce corporate profits by making borrowing cost rise. This stifle future investments which in turn adversely affect the stock market. There is hesitation on the FED part because COVID19 is affecting employment recovery...which was one of the FED's goals in reducing the interest rates to near zero.

The FED has a balancing act of controlling inflation vs corporate profits. I suspect the FED will not let it get beyond 6 or 7%. In exchange for raising interest rates, they will probably sacrifice a higher unemployment number and allow some stock market decline because those factors are "transitory".

 

[Markola]

^^^^^^ I wouldn’t want to predict inflation any more than any other thing in finance. But regardless of the inflation rate, I think it will be 15-ish % less for us, because that’s about how much of our spend goes to mortgage principle and interest. Another large chunk is pretty discretionary and flexible, i.e. Travel, so I won’t worry too much about that portion, either. And much of the rest can be tilted with substitutions.

I’m alert and not sanguine, but I am not panicked by the normal media fear-mongering in search of some Doomsday threat or other to write about.

 

[Mulligan]

Rents do not show up in CPI

Is this not correct?

One economic tool which has stood the test of time is the shelter component of the Consumer Price Index (CPI). Provided by the U.S. Bureau of Labor Statistics (BLS), the shelter index is a measure of the costs associated with housing, not including investments and upgrades. It’s a major component of CPI — making up 32.8% of total CPI — and has been included since its inception in 1913.

The two main components of the shelter index are the owners’ equivalent rent of primary residence (23.8% of CPI) and rent of primary residence (5.9% of CPI). The cost of shelter for renter-occupied housing is rent, while owners’ equivalent rent measures homeowners’ expected rent if they were renting their homes in the current market. The majority of the rest of the shelter index is made up of lodging away from home expenditures, such as housing at school and hotels.

https://arbor.com/blog/how-does-rent-factor-into-the-consumer-price-index-cpi/

 

[2177V]

sigh.

Due to props 13 and 218 CA property taxes are significantly lower than the national average, approximately 0.73% vs. 1.07%. So, for property owners anyway (and especially long term property owners), the whining about high CA taxes is significantly offset by a lower property tax.

Sigh.

Not true for Californians who recently purchased a house in California. On my tax bill, I see a line item of 1% and then the fees are added so I am paying 1.07% which is the national average.

You are not wrong because it is well known that California home owners who purchased their homes a long time ago pay less property taxes that their neighbors who recently purchased their homes. You did qualify your statement with the words “especially long term property owners” but the whining about high taxes in California is justified for some people…but not for you.

 

[2177V]

Is this not correct?

One economic tool which has stood the test of time is the shelter component of the Consumer Price Index (CPI).

https://arbor.com/blog/how-does-rent-factor-into-the-consumer-price-index-cpi/

I agree. I am glad that you supported your statement with the link. Common sense should make Rent as part of the CPI and inflation.

On a separate and related issue. My wife owns a small business with a 5 year lease which expires in 3 months. The building owner is demanding a rent increase of 15%. This forces my wife to increase her prices to her customers.

Greed has a trickle down effect and can lead to inflation.

 

[OldShooter]

2.8%/year is greed? "demanding"seems a little strong, too.

 

[Montecfo]

These threads seem to reveal that the components of CPI are not well understood by a lot of us.

 

[2177V]

2.8%/year is greed? "demanding"seems a little strong, too.

My comment stated 15% rent increase from the previous 5 year lease. After the 1st year of the 5 year lease, the rent increases 3% for year 2,3,4,5 so the total rent increase is 15%+3+3++3+3 or a total of 27%. It is NOT 15%+0+0+0+0...although I wish that would be the case. The first year rent increase of 15% is greed. The rest of the rent increases is reasonable. My wife has to pass on the rent increase to her customers. I just want to illustrate one of the reasons why inflation is occurring in small businesses.

This also illustrate why I re-allocate some of my wealth to increase my income producing real estate. I have been a landlord before so I am familiar with that business.

 

[karen1972]

I think the problem is that some of these are just so in your face all at once its hard not to flinch.

For example my home insurance is up for renewal and the quote is 27% higher due to replacement costs.

My health insurance spiked 22% (while I know that age related, others wouldn't)... my BFs only went up 5% for same plan so has to be age related as I hit the big 50.

So yeh when you start getting some of these things and they are so out of whack from what you were expecting, its jarring.

 

[OldShooter]

... After the 1st year of the 5 year lease, the rent increases 3% for year 2,3,4,5 so the total rent increase is 15%+3+3++3+3 or a total of 27%.

That's actually not the way the arithmetic works.

... It is NOT 15%+0+0+0+0...although I wish that would be the case.

From your post that was not at all clear.

... The first year rent increase of 15% is greed. The rest of the rent increases is reasonable.

Well, I'd guess that the 15% is probably to bring the rent up to market. I don't know how to judge "reasonable" other than to test whether it seems to keep the rent close to a market rate.

... My wife has to pass on the rent increase to her customers. I just want to illustrate one of the reasons why inflation is occurring in small businesses.

Yup. That's the way the economy works. Landlord's costs are going up and the market is allowing him to raise prices, so he is doing it. Hopefully your wife has some pricing power as well.

... I have been a landlord before so I am familiar with that business.

Yup. 25 years as a landlord for me plus other small and medium sized businesses. Last 10 years pro bono mentor to entrepreneurs and small business. Maybe 200 clients in total. Right now I have a cookie company, a sandblast company, a financial advisor (RIA), a chimney repair company, and a guy who has developed and patented a toy to improve STEM education. It's great fun but making the numbers work is always a challenge.