Why Isn't My Life Getting Cheaper? The Truth About Fed Rates and Inflation

When you turn on the news on TV, you hear that the Fed rates have decreased, and inflation has gone down. News anchors shout it out excitedly, and we feel a little happy too, even though we don't really understand the underlying finances or whether anything has actually decreased, or if it's just a mathematical number that has gone down, causing the news anchors to get so excited.

So, after hearing this news, when I go to the market and see the prices of milk, bread, etc., my mind gets blown. My car insurance bill arrives, and it's higher than last year. Then we think, "The Fed rates have decreased, the news people are saying inflation has gone down, so why isn't anything changing in my life? Why aren't things getting cheaper? Are these people lying?"

To be honest, they're not exactly lying, but they're not telling the whole truth. So let's understand what the complete truth is:

1. The Speed of Inflation: Lower Rate vs. Lower Prices

First of all, people have a misconception that a decrease in inflation means prices will now go down, but this is a wrong assumption. Inflation refers to the rate of increase in prices, not how much prices are increasing or decreasing.

To understand this simply, imagine a car that was running at a speed of 100 km/hr for the last two years (meaning inflation was increasing rapidly). Now the Fed has applied the brakes, and the car's speed has reduced to 40 km/hr.

This means inflation is still increasing, but its speed has slowed down. The news people are happy that it has decreased, but actually, only the speed has decreased; inflation is still rising. And a rate cut means that the rate, which had increased from $5 to $8, will now not increase further; it will remain at $8, it won't move from $8 to $10. That's the only relief. And if you're thinking that the rates will go back to what they were in 2020, then sorry boss, that world is long gone. It might come back again, but if that happens, the economy will crash.

2. Why Services Don't Get Cheaper

The second thing is that services never get cheaper. You might have noticed that TVs and mobile phones are getting cheaper (though not anymore due to the chip shortage), but at one point we felt that computers, which were previously unaffordable, are now affordable, so in a way, they became cheaper.

But services like haircuts, car insurance, restaurant food... all of these are getting more expensive. Why? Because the main cost in these services is human labor. Since people's salaries have increased significantly in the last few years, if your barber increases his own income, will he reduce the price of your haircut? No, he'll increase the price so that his income also increases. So once someone's service rate increases, it doesn't decrease. Even if we reduce the Fed interest rate to zero, that barber won't cut your hair at the old rates. That's why the cost of living isn't decreasing either.

3. The Lag Effect: Why Relief Takes Time

It takes time for the effects to be felt. We think that if the Fed cuts rates tomorrow, we'll suddenly get relief today, and shopkeepers will reduce the prices of brands and everything else in a single day. But that's not the case; it takes 6-12 months for this effect to reach us because what we are feeling now is the effect of inflation from two years ago.

Companies are still recovering the costs of the loans they took out, and they're doing it by passing those costs on to us. To put it simply, if a shopkeeper bought an item in bulk five months ago at $100 per piece, and the Fed rate was cut, would he sell you that $100 item for $80, incurring a loss himself? No. He'll recover his old costs first before applying the new Fed rate to new items.

4. The Psychology of Prices

Our minds are stuck on the old rates, like the rates from 2019. Our salaries have increased significantly, but we still think, "This item used to cost $4, now it's $7, that's unfair!" This is a misconception because if your income increased, the other person also had to increase their income, so they did. Both sides are balanced now. So, you should accept that $7 is the normal price now.

What Should You Do Now?

So, after considering all these things, let's think about what we should do: