Inflation: Is it Live or is it Memorex?

​By Brad Thomason
 
 
I'm aware that saying "I told you so..." is a sort of tacky thing to do.  So I'll step as lightly as I can here. But the fact of the matter is that over the past ten or fifteen years I've had a number of discussions about inflation with people who have looked at me with pity in their eyes.  Poor Brad, he's really stuck in the past on this whole inflation business.
 
Failing to account for inflation when doing retirement income projections is one of the most certain pathways to gloriously incorrect outcomes.  It's something you always have to account for, so it's always part of the discussion.  Despite the fact that inflation does not occur in a purely uniform manner year to year—more on that in a minute—you still typically put it into the projection model as an annual rate.  I have persisted in proposing 3% as the rate to use, these many years, despite the fact the annual changes have been less than that for a long time. A fact which my interlocutors have pointed out; used as a basis for skepticism (even cynicism) for accepting the suggestion (a la it-was-only-2%-last-year-so-why-can't-we-just-use-2%?); and which is the root of the impression that my suggestion was outdated.
 
But there are a couple of reasons I never relented.  First, medical inflation has had a tendency over the last 30-40 years to run higher than general inflation.  And which age group does most of the medical spending, class?
 
The second reason is because of what we're seeing now.  No, I didn't predict the current inflation situation.  But I have argued—again, for years—that if changes to CPI and other handy measures were not fully capturing all of the "actual" inflation then there would come a day when we could see some catch-up inflation.
 
Even this wasn't really a prediction, by the way.  Just an acknowledgement that what happened back in the 70s could happen again someday.

As a quick demonstration, nine years of 2% inflation followed by one year of 13% inflation will put price levels roughly equal to where they would have been had there been a decade of smooth 3% inflation.
 
I don't know how much of the recent inflation is actual, current inflation and how much of it is echoes from the past, finally catching up with us.
 
Nor is it particularly important to spend any time trying to figure it out for doing retirement planning.
 
But there are a couple of important takeaways which I'll briefly point out.
 
First, don't fall into the trap of thinking that year-to-year changes tell the whole story.  History says the changes do not occur smoothly from one period to the next—and there's certainly nothing here in the present that would lead one to conclude that the historical norm has been supplanted.
 
Second, if you do use a higher rate for planning purposes than what seems to be taking place, it will give you the impression that your results are running ahead of your projections.  It will seem that you have more money than you thought you would. You might be tempted to think of that extra as a windfall; a windfall that you can treat as fun-money for buying something silly.  I'd think twice about that.  If we get a repeat of present-day circumstances out there in the future, it will be wise to have some cushion to absorb the blow. Otherwise you could find yourself behind where you needed to be, the exact opposite of where you thought you were before the full flock of inflation chickens came home to roost.
 
Inflation is one of the wild forces that is a perpetual part of the financial landscape.  Like other wild forces—fire, flood, fashion trends, etc—it is under no obligation to behave itself or act uniformly.  As such it's a good idea to always be a little skeptical that you have its full measure at any given moment, and to arrange your affairs in such a way that a surprise surge isn't a devastating event.