Why Prices Don't Fall When Inflation Slows

Many consumers are currently facing a confusing economic paradox: while news reports indicate that inflation is cooling, grocery bills and service costs remain stubbornly high. To understand this phenomenon, we must distinguish between the deceleration of price increases and a literal drop in price levels.

The Distinction Between Inflation and Disinflation

Inflation, by definition, is the persistent rise in the prices of goods and services, which erodes purchasing power. The podcast highlights a stark example: in 2013, five euros could purchase a basket of essentials—pasta, milk, and coffee. By 2023, that same basket required nearly double the investment.

When economists state that inflation is "slowing," they are referring to disinflation. This means that prices are still rising, but the rate at which they rise is decelerating. For instance, inflation peaked in 2022 and slowed to 2.5% by June 2024, down from 5.5% in June 2023. This is not a reversal of price hikes, but merely a reduction in the speed of the ascent.

Why Costs Stabilized but Didn't Drop

Prices for goods are heavily influenced by the cost of raw materials (such as wheat and sugar) and energy sources (gas and electricity). Recent global disruptions—specifically the "conflict in Ukraine, climate change and the pandemic aftermath"—forced these costs to skyrocket.

While these input costs have recently "mostly stabilised," leading to slower price growth in shops and occasionally minor dips in fuel prices, they have not plummeted to pre-2020 levels. The market has simply reached a new, higher equilibrium, meaning the cost base for retailers remains significantly elevated compared to previous years.

The Wage Factor and Economic Rigidity

One of the primary reasons prices cannot simply "rewind" is the relationship between inflation and wages. When the cost of raw materials rises, wages often increase to compensate for the cost of living. However, these wage increases are "sticky." Once the minimum wage or general salary levels are adjusted upward, they do not decrease when inflation slows down. Since labor is a major component of the final price of any product or service, businesses cannot lower their prices without incurring unsustainable losses.

The Dangers of Deflation

Some might argue that true deflation—a general decline in prices—would be beneficial for consumers. However, economists warn that deflation is a dangerous economic cycle. If consumers expect prices to continue falling, they tend to "delay purchases to get better deals." This reduction in consumer demand leads to lower production levels, which subsequently causes "more unemployment and lower wages." Ultimately, this creates a downward spiral that is far more damaging to the economy than controlled inflation.

Conclusion: The Goal of Stability

To maintain economic equilibrium, the European Central Bank targets a 2% inflation rate. This goal is designed to foster growth and stability rather than a return to the prices of the past. While consumers may find it frustrating that prices do not return to 2020 levels, understanding the difference between disinflation and deflation reveals that the current economic environment is actually a sign of stabilization rather than a failure of the market. We are not experiencing a price reversal; we are experiencing a return to a manageable, predictable growth pattern.