It disappeared, but it was a traumatic process and it took a long time for people to be convinced it was for real. Paul Volcker, the chair of the Federal Reserve during the first two years of President Barack Obama’s first term, so angered the American public by raising interest rates steeply in order to curb it that he received death threats. In Europe, they regarded it as a cruel foreign invader; it took the continent a long time to recover from the shock. In Israel, people long priced houses and other assets in dollars because, who could rely on the value of the local currency?
Inflation is dead today. In fact, it is so dead that its sister deflation – who some would argue is the more dangerous of the two – is considered the real problem of our time. Since 2008, we’ve been warned that if interest rates continue to remain low and central banks continue to print money, inflation will return. In an in-depth analysis, The Economist concluded that while the world shouldn’t be complacent, there’s no immediate cause for concern.
But if you ask ordinary people if prices aren’t rising, if the cost of living has remained steady for the past 20 years, if it isn’t getting harder and harder to get through the month, you get a response that’s very different from what the central bank economists and government statisticians tell you.
The inflation that everyone complains about isn’t tucked away in small items in the official consumer price index. It exists in several major household-spending categories.
To understand how inflation was eradicated, you have to go back to the place where it happened. It began at the end of the Cold War and the collapse of the Soviet bloc. It continued with the entry of China into the World Trade Organization.
Global trade grew to unprecedented heights. Many countries, China in particular, began manufacturing and exporting products on a massive scale – everything from toys, textiles, tools and housewares to advanced electronics, computers, steel and machine tools. Cheap labor and a currency that was kept artificially weak by the authorities enabled China to sell cheaply to the world things that had once cost much more.
Goods that were once considered luxuries are now widely affordable. A 60-inch television set that cost $8,000 in 2012 can now be had for less than $1,000. A 1-gigabyte USB flash drive that cost over $1,000 in 2000 sells for less than $2.
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From 2000-18, the U.S. consumer price index rose 46%, or an average rate of just 2% a year. Wages rose slightly more than that, so that in those 19 years salaries after inflation increased 10.4%. So why do American feel they have lost out?
One reason is that two other major expense items have greatly increased the cost of living, namely higher education and health. Even Americans who have health insurance pay a high deductible and medical costs are the highest in the world, sometimes hundreds of percent higher than in Europe and Israel. Health care spending in the U.S. has soared 56% in real terms in less than 20 years, an increase that has come at the cost of the average American’s health and even life expectancy.
The cost of a higher education in America has grown even more rapidly, or 57% in real terms. Young people even from middle-class families have to mortgage their futures by taking out huge student loans to study at a university, and not just private institutions.
Another major household expenditure – housing, whether purchased or rental – has also weighed heavily on American households. Home prices have risen 31.5% in the past 19 years after inflation, or three times the pace of real wage gains.
And what about Israel? The Israeli consumer price index rose 33% from 2000-19 inclusive, an average of 1.5% annually. There were even years when inflation was negative or zero during this period.
But home prices rose so much in these years that it is hard to understand how we’re not all living in the streets despite an 18% real rise in wages. According to the Central Bureau of Statistics, they rose nearly 70% in nominal terms before the onset of the coronavirus and 25% in real terms. For Israelis, that’s a figure that’s hard to live with, even if the housing component of the inflation index is small enough that they look like they’ve come out ahead between 20 years of low inflation and rising wages.
And, it’s not just housing that’s raising Israeli living costs. Due to the growing role of private supplementary services and private medical insurance, medical costs have climbed, too. Both categories rose faster than the increase in wages, or close to 19%.
Only in education were Israelis spared: Those costs, which in the case of higher education were low to begin with, have risen only 5.5% after inflation over the last two decades even after taking into account the fees parents pay to public schools.
In sum, what we’ve seen in the era of “low inflation” is in fact a melange of differing price trends. Telecommunications costs have plummeted; affordable electronics fill our homes. In the 1970s, a plastic doll was regarded as an expensive present you might give for a special birthday; a pair of Adidas sneakers could only be had as a gift from rich relatives abroad. Today, however, every 10-year-old has a smartphone in his or her pocket worth 2,000-4,000 shekels ($620-$1,240).
But if you weigh the consumer price index slightly differently, so that housing and health care have a bigger place, it’s doubtful whether the central banks could say with such confidence that there’s no inflation.
What would happen if they raised interest rates in line with the housing price index? Apparently it would be much easier to buy a home. But the Israeli and global economy would have looked completely different.