Latest / Wages and Prices with Fexingo: Cost of Living, Pay Raises, and Workers' Purchasing Power / Why Your Raise Feels Smaller Than Your Costs
Transcript
- Lucas: There's this really striking disconnect right now. Core inflation hit an annual rate of 3.3 percent in April, right in line with what economists expected. Average hourly earnings are up, too — about 4.1 percent year-over-year. So in theory, the average worker is outrunning inflation. But almost nobody feels that way. Luna: Yeah, the gap between the data and the public mood has been the defining story of this whole cycle. We did a whole episode on sentiment hitting a record low despite a strong labor market. But I think there's a deeper psychological layer here. Lucas: I think so too. And it ties into something behavioral economists call 'reference dependence.' Basically, people don't evaluate their financial situation in absolute terms. They compare it to a reference point — usually, what things used to cost or what they used to earn. Luna: So it's not just about the rate of inflation, it's about the cumulative price level. Lucas: Exactly. Even if prices are only rising at 3.3 percent annually, the fact that they are 20 percent higher than they were four years ago means that reference point has shifted. Every dollar you earn now buys less than it did in 2020, and that memory doesn't fade quickly. Luna: And there's a related concept called 'loss aversion' — losses hurt about twice as much as equivalent gains feel good. So when you get a 4 percent raise but prices are 20 percent higher than your anchor point, you're still feeling the loss. Lucas: Right. That's why the vibecession — that term that gained popularity a couple years back — persists even as real wage growth turns positive. People are anchored to the pre-inflation shock price level. And until that anchor resets, a raise that beats inflation by half a percentage point still feels like a loss. Luna: Let's get concrete. The PCE price index — the Fed's preferred inflation gauge — stood at 130.9 in April, up from 130.38 in March. That's about 20 percent higher than January 2020. Meanwhile median weekly earnings are about 1,204 dollars, up from 1,159 a year ago. But that still feels insufficient. Lucas: Because the 1,204 figure is measured against a baseline of what rent, groceries, and gas cost in 2020. And those categories have been especially sticky. Core services inflation is still running hot. So the basket of goods that matters most to households hasn't come down. Luna: And there's another factor: the depletion of pandemic-era savings. A lot of households built up a buffer during the stimulus years. That buffer is now largely gone, so every price hike is felt directly rather than absorbed by savings. Lucas: That's a huge point. The Federal Reserve Bank of San Francisco estimated that excess savings peaked at around 2.1 trillion dollars in 2021. By early 2025, they were essentially depleted. So now, when the price of eggs goes up, it hits your checking account immediately, not a cushion. Luna: That creates a feedback loop. You feel poorer, so you pull back spending, which could slow the economy, but it also makes you more sensitive to any remaining inflation. Even a 3.3 percent inflation rate feels like 5 percent when you have no buffer. Lucas: And the labor market, while still decent, is no longer red-hot. Fed's Kashkari said this week that the inflation fight takes priority because the labor market is in 'decent shape.' So you've got a situation where wages are rising, but hiring is slowing, and workers feel less leverage. Luna: If walking through the economy with us has made something click for you, it's worth knowing that listener support is what keeps this show ad-free and independent. A couple of dollars a month genuinely makes a difference — just buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a simple way to help us keep doing deep dives like this one. No pressure, but if you've gotten value from the show, it's appreciated. Luna: Back to the psychology — there's also this idea of 'money illusion.' People tend to think in nominal terms. So if you get a 4 percent raise, you think 'great, I'm doing better.' But if inflation is 3.3 percent, your real gain is only 0.7 percent. And if your reference point is 2020 prices, you're still down. Lucas: Right. And that real gain of 0.7 percent is actually quite small historically. In a typical year, real wage growth might be 1.5 to 2 percent. So even when you outpace inflation, you're not catching up to the lost ground from 2021-2023. Luna: Let's look at the employment cost index — it's a broader measure that includes benefits. The wages component hit 177.5 in the first quarter of 2026, up from 176.23. That's about a 0.7 percent quarterly gain. Annualized, that's around 2.8 percent real wage growth if inflation is 3.3 percent. But that's not what workers see. Lucas: No, because benefits like health insurance have been rising even faster than wages. That's something we covered in an earlier episode. So the take-home pay increase is even smaller than the headline wage number suggests. Luna: And then there's the geographic variation. In some states, wages are growing much faster than the national average. But in high-cost areas like the northeast and west coast, the wage-price gap is still negative. So the national average masks a lot of pain. Lucas: That's worth unpacking. The national data shows the average worker is beating inflation. But the average worker in New York City or San Francisco is not. Rent in those cities is still up 30 percent from 2020. So even if you got a 20 percent raise over four years, you're still behind. Luna: And that's where the reference dependence really bites. If your reference point is your 2020 rent, and it's now 30 percent higher, your raise feels like it's been eaten before you even get it. Lucas: Exactly. And the thing is, economists talk about 'sticky prices' and 'sticky wages,' but there's also 'sticky perceptions.' Once people form a view that the economy is bad, it takes a long time to change. Even if inflation falls to 2 percent, people remember paying less. Luna: Yeah, and that's why the Fed can't just declare victory. Even if the data shows inflation is under control, the public's lived experience is different. And that affects consumer spending, which is two-thirds of GDP. Lucas: So what's the way out? Time. Eventually, the reference point resets. If we have two or three years of 2 percent inflation and consistent real wage growth, people's anchors will shift. But right now, we're in that painful middle ground where the math says things are improving but the feelings say otherwise. Luna: And that's the vibecession in a nutshell. The data is better than the sentiment, and the sentiment is the reality that matters for economic behavior. Lucas: I think that's the key takeaway. The economy is not as bad as people feel, but the feeling itself is a real economic force. It shapes spending, saving, and even political outcomes. And until the reference point shifts, that disconnect will persist.