Commentary: It Sure Doesn't Feel Like Low Inflation

The products we buy aren't the problem -- most of them are made cheaply abroad. It's homegrown services that hit us in the wallet

By Kathleen Madigan

On May 6, the Federal Reserve said policymakers are worried about deflation. That statement might have you scratching your head and wondering: "If prices are falling, how come I can't make ends meet?" Are Greenspan & Co. in a Wonderland, where up is down? Or are you just bad at handling your money?

Relax. You're not clueless. Yes, the Labor Dept.'s consumer price index shows the U.S. inflation rate stood at a modest 3% for the year ended in March. But the CPI is designed by economists to capture a typical basket of goods and services bought by an average household. While a useful yardstick overall, it just can't match every household's spending habits. Truth is, your personal inflation rate says as much about your age and family status as it does your budgeting skills.

Bear in mind that consumer spending is divided into two phases. First, we buy stuff. It's this acquisition process that shapes the public's perception of inflation because economists and the press focus so heavily on data from the holiday shopping season, retail sales, and car buying. This segment of consumer spending is where prices are falling most markedly.

Once we get that new stuff home, however, we have to take care of it. That's the maintenance phase of consumer spending, which makes up the bulk of household purchases. Much of it is spent on services -- from doctor's visits to trash collection and education -- and that's where inflation is on the rise.

Consider, for instance, what it takes to buy and maintain a car and home. Vehicle prices fell 1.5% over the past year. But insuring that car cost 8.9% more, while gas has shot up 38%. Likewise, thanks to falling interest rates, the monthly payment for a $200,000 mortgage has slipped 10% since last spring, while heating oil spiked by 50%.

Maintaining the body and mind is getting more expensive, too. Medical care prices are up 4.3% and college tuition has risen 7.3%. And that's just in the year ended in March. Over the past decade, health inflation averaged 4% per year, and tuition increases crept up 5.5% each year. Both rates are well above the decade's average gain of 2.5% for the overall CPI.

Why are services prices going up while goods keep falling? Think globally. More and more stuff bought in the U.S. is made overseas, either in emerging economies such as China, where low labor costs keep prices down, or in developed nations, which have benefited, until recently at least, from relatively cheap currencies. There are no imported substitutes for most services, though. From your local dry cleaner to your doctor and hairdresser, none face the same competition. In addition, service industries haven't enjoyed the big productivity gains that U.S. manufacturers have racked up for the past decade. That means service providers have to boost prices in order to cover rising labor costs.

Whether these opposing price trends leave you more giddy than glum depends largely on demographics. Younger adults who are setting up new households benefit the most from the bargains to be had in furniture, cars, and electronics. The childless can ignore rising daycare and education costs.

If you are older, say over 40, you've likely already made most of your big-time acquisitions. Except for the occasional new car or redecorating splurge, your budget is made up largely of maintenance items. And if you have a family, you're also getting squeezed by rising college tuition costs. Then there's larger premiums, deductibles, and co-pays in your company health plan, as well as the need to pile ever more into retirement savings. Older still? Then your personal inflation rate feels the push from higher drug costs.

Maintenance inflation is all the more onerous because we pay the bills at least monthly. Consequently, the rise in prices for cable hookup, electricity, and heating oil eat into our budgets on a regular basis. And mailing those bills costs 10.5% more than a year ago, thanks to the rise in postage.

Of course, your mail carrier isn't the only government entity with a hand out. While the CPI doesn't capture such outlays, it's safe to say state and local taxes are also taking a bigger bite out of the monthly budget. Although tax rates on the federal level have fallen, state and local governments are boosting their taxes to close budget gaps. According to the Tax Foundation, states have already increased taxes by about $8.3 billion in the current fiscal year, including levies on cigarettes, retail sales, gasoline, and income. And with local deficits hitting record levels, even property taxes are being jacked up.

Faced with a stack of ever-increasing bills, it might seem impossible to escape from inflation's bite until you finally leave this mortal coil. But even that's not the case. Service inflation will take one last nip after you're gone: Funeral costs have been rising 4% annually for the past five years.

Business Outlook Editor Madigan's property taxes recently rose 18.5%.

    Before it's here, it's on the Bloomberg Terminal.