The Economy is Doing Well, But Inflation is Overshadowing Positive Growth   

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Despite high interest rates and stubborn inflation, the economy is growing remarkably well. All the major indicators we use to gauge its health – and how families and businesses are faring – are all strongly positive:

  • Wages are growing close to 4% on an annual basis, which is above the rate of inflation.
  • The unemployment rate is low, at 3.9%.
  • Consumer spending was up in March (the latest available data).
  • On the business side, business investment is rising.

Furthermore, the economy grew almost 3% in 2023. And as of this writing, the Atlanta Federal Reserve’s real time tracker of economic growth estimates  3.8% growth for the second quarter of 2024.

But despite all this positive data, many Americans do not believe the economy is doing well.

Why it matters: Consumer sentiment plummeted in May, dropping from April when it was already low to begin with. It is lower now than it was in March of 2020.

Small business optimism is at its lowest level since 2012. Manufacturers and service providers’ optimism says both sectors are in recession. According to the MetLife and U.S. Chamber Small Business Index, inflation has been the overwhelming top concern among small business owners for nearly two years.

Inflation’s role: The key data point that ties together these seemingly irreconcilable viewpoints is inflation. It’s still too high, and it’s making everyone feel the economy is in worse shape than it is.

  • For families, it makes them feel as though they can’t get ahead. They are earning enough to keep up with day-to-day expenses, but they can’t save for the future, like their kids’ education or their own retirements.
  •  For businesses, rising wages, particularly for small businesses, are putting tremendous strain on profit margins. Every time a business hires a new worker, they are paying them more than they paid their last hires. That means they now need to bump up the pay of those recent hires, as well as existing employees, to maintain an equitable pay scale. So, their wage bill rises considerably with each badly-need worker they bring on.

Businesses find it harder to pass higher costs on to customers because they are tired of rising prices and are less willing to pay them. This is squeezing businesses’ bottom lines.

Feelings about the economy would improve, as would businesses’ margins, if inflation would come down further. That will happen – eventually.

Inflation is still above the Fed’s 2% target. At last reading it was 3.4%. That is much lower than the 9% peak we hit in 2022, but still too high. It is going to take a few more years before we finally get inflation down to 2%, based on the Fed’s own projections.

In the meantime, inflation will continue to be at the front of people’s minds in large part because prices are still rising.

Be smart: Inflation doesn’t end with prices reverting to what they were before inflation took off. It ends with prices rising only at 2%, instead of at higher rates.

From an economic perspective, slower price increases are the best answer to inflation because falling prices, or deflation, is problematic, too.

  • With deflation, businesses would see lower prices for their goods and services, but their workers wouldn’t take lower wages and their suppliers are unlikely to lower their prices. This would imperil businesses across the economy.

For families it is the accumulation of prices that matters, not the annual figures we focus on. When we report on inflation data, we look at the change in prices over the last year. For instance, prices in April of 2024 were 3.4% higher than in April of 2023. However, people don’t feel price increases on an annual basis. They compare what the prices of their groceries were, for instance, before inflation took off to what it is now. They want those groceries to go back to their pre-inflation costs.

What’s next: In aggregate, prices have risen 18% since inflation took off in March 2021 and that’s what people sense when they think about inflation. Wages, although outpacing inflation the last year, are up only 9% in total since March 2021. A new permanently higher price level takes time for them to accept. It is going to take a few more years for them to acknowledge prices aren’t going back to where they were before.

  • Despite the ongoing strength of the economy, they will feel sour until they’ve grown accustomed to permanently higher prices because of their higher wages.

Bottom line: Despite positive economic signs, higher prices are creating strains on the ability for families to save and businesses to grow.  Economic growth and rising wages will help Americans adapt to the higher prices they have seen.

Curtis Dubay was a Keynote Speaker at the 2024 FRA Annual Meeting