Finding Inflation’s Silver Lining

Planning Reflection | December 16, 2022

After more than a decade of tepid price increases, rising inflation has become a core focus for both consumers and businesses. Google searches for “inflation” have risen more than 230% over the past two years.¹ “Supply chain issues” has entered the common lexicon and resulted in both humorous and informative posts circulating on social media. Even the satirical website The Onion posted a headline last month lamenting that “higher prices may force Americans to eat reasonable portions on Thanksgiving.”

As inflation emerges from a long hibernation, the impact on consumers is acute. In particular, housing, electricity, and food costs have increased even more than the CPI average. Both consumers and businesses have been forced to make adjustments, and the pace of change has led to concerns about future costs and financial well-being. In thinking ahead, we acknowledge that inflation has been a normal and recurring part of economic growth throughout history – and can have some silver linings.

Policymakers have learned to proactively address these recurring price increases by building in inflation-linked increases in certain areas. This helps provide a salve to the net impact of rising costs, and these adjustments can have material benefits for retirement income programs and savings limits.

In 2023, the Social Security Administration expects to increase monthly benefits by 8.7% for the annual cost of living adjustment (COLA).² This will be a welcome boost for Social Security recipients whose current monthly benefits may not be enough to handle price increases on everyday expenses. For those not yet receiving Social Security benefits, this large COLA adjustment will still be factored into benefit amounts once they claim, even if they wait until age 70.

For savers, there are material benefits as well. First and foremost, savings accounts and CDs are finally paying a non-zero amount of interest.  Since the Federal Reserve began raising interest rates earlier this year, many banks have, in turn, increased the rate they are paying on consumer savings accounts. While the national average still sits at 0.24%, many reputable online banks and local credit unions have high-yield savings accounts and short-term CDs with rates at 3% or higher.³ This allows savers to earn more on their emergency fund or other short-term savings and can be a valuable complement to the growth and risk of a long-term investment portfolio.
 
For those still in the workforce, inflation-linked adjustments have helped push 401k limits and other retirement savings limits higher for next year.  The IRS announced that the contribution limit for employees who participate in 401k or 403b plans will be increased to $22,500, up nearly 10% from 2022’s limit of $20,500. The over-50 catch-up contribution limit is increasing by 15% to $7,500.⁴ Individuals can now contribute substantially more in 2023 and deduct that amount from their taxable income. This increased capacity to save into tax-deferred retirement plans is a boon for employees and business owners alike.

Despite the future benefits of higher Social Security and savings limits, the current reality is that prices have been increasing rapidly. The CPI report for November indicated that prices grew at an average rate of 7.1% over the past twelve months, with some categories of consumer goods and services increasing more quickly than that average.

The most acute example of higher expenses is energy costs, which rocketed higher early in the year due to the war in Ukraine. The cost increases have been more painful in Europe, but even within the US, we’ve seen energy costs jump higher in the last twelve months. Electricity is now 14.2% more expensive, gasoline has gone up by 10.1%, and natural gas is 15.5% higher.⁵ A silver lining is that all three energy inflation numbers were higher earlier in the year and have seen some welcome declines in recent months.

Healthcare is an example of a category that has seen slower price increases than the broad CPI average. In fact, the impact price caps or cost reductions on various medications – especially an Alzheimer’s medication that contributed to a higher cost increase the prior year – means that Medicare Part B premiums will actually decrease slightly in 2023 compared to 2022.⁶ While consumers can be grateful for mild medical cost inflation in the current year, recent history has shown this category to regularly outpace core inflation, and we don’t expect that longer-term trend to change as demographics continue to age and need additional care.

Corporate earnings are another area where the pressures of inflation arise. Businesses are facing higher energy expenses to operate their facilities, and earnings calls have cited higher fuel costs transporting goods to market. These factors, as well as higher wages for employees that can accompany inflationary periods, will likely dampen profitability over the coming year. Companies that lack pricing power – meaning that they cannot easily pass costs on to customers – historically suffer the most because they are forced to absorb the cost increases by taking a hit to their profit margin. Stock and bond prices have declined this year in part because investors are expecting these inflationary pressures to persist into 2023.

Why do current price increases feel so jarring if inflation has been a normal phenomenon throughout modern economic history? In part, the answer is that inflation has been historically low for the past decade alongside historically low-interest rates. Consumers and investors had been lulled into a false sense of price stability.

During the decade of 2010-2020, inflation in the US averaged 1.8%. If we zoom out to look at the 60- year period from 1960-2020, that average is much higher at 3.7% annual inflation.⁷ This average indicates that there were periods, particularly in the late 1970s and early 1980s, when inflation was running even higher than it is today. The global economy is transitioning back toward historically normal interest rates and inflation, and consumers and businesses must make material adjustments. That process is rarely easy, and the amplified uncertainty during the transition can push asset prices down and inflation up in the short term.

For consumers, this is a time to evaluate current expenses and reaffirm that your financial plan and regular spending match your family’s priorities as well as your current resources. Neither we nor the Fed, much to their chagrin, can control the exact pace of inflation moving from current highs to more normalized levels, but we can take advantage of some of the silver linings created during this inflationary period.

Resources

¹ 5-year Google search volume for “inflation” Google Trends

² Fact Sheet: 2023 Social Security Changes SSA.gov

³ 7 Best Savings Accounts of December 2022 Nerdwallet

⁴ 401(k) limit increases to $22,500 for 2023 IRS

⁵ 12-month percentage of change in the US CPI by expenditure category, November 2022.  Statista

⁶ Medicare Premiums Drop In 2023, But That’s Not The Full Story.  Forbes

⁷ Historical CPI for All Urban Consumers (CPI-U) U.S. Bureau of Labor Statistics