Think Lower Inflation Means Cheaper Prices? Think Again
Andrew Lokenauth, money expert and owner of Fluent in Finance, has noticed this misconception all the time when talking to his clients about financial planning.
'The thing is, most people mix up 'disinflation' (slower price increases) with 'deflation' (actual price drops). And I get it — the terminology is confusing as hell. When headlines scream 'Inflation falling to 3%!' it sounds like prices must be dropping too.'
Here's what's really going on.
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According to Dennis Shirshikov, professor of finance at City University of New York and head of growth and engineering at Growth Limit, the false idea that lower inflation means lower prices comes from a fundamental misunderstanding of what inflation actually measures.
'Inflation is the general price level, not the absolute prices.'
This is what's happening: When the inflation rate decreases, all that is happening is that prices are still increasing, but at a slower rate. This can be misleading to a lot of people, Shirshikov explained, because most people would expect that less inflation means that prices would be going down rather than going up at a slower rate.
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'Picture the cost of a gallon of milk. Milk costs 5% more this year than it did last year when inflation [was] 5%. Even if inflation drops to 2%, the cost of milk would still go up, but at a much slower pace — only 2%, not 5%,' said Shirshikov.
So basically, although that may be a welcome development in the sense that it will take pressure off household budgets, it's important to recognize that the prices are not actually falling, they are simply rising less rapidly.
If you were relying on prices to act as a sort of after-inflation cut in the price of money itself, it's time to reset your expectations. The best thing is to concentrate on how to manage and control other parts of your budget and investment strategy.
As the price of goods goes up in the coming months, you may want to see if there are opportunities to reduce expenses, diversify investments and lock in fixed prices for necessary services now to avoid paying more later.
'Let's face it, being proactive with your financial planning is important for managing inflation — even when it's not as aggressive as before,' Shirshikov said.
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