Is Inflation Really as Bad as You Think…
Is Inflation Really as Bad as You Think? Why Your Brain and Your Central Bank Are Both Getting It Wrong
Walk into any grocery store and the sticker shock feels undeniable. Prices are high, wallets feel thinner, and the instinct is to declare an inflation crisis. But here's what three decades of macroeconomic analysis has taught me: what we feel about prices and what is actually happening in the broader economy are frequently two very different things — and conflating them leads to bad personal financial decisions and, more dangerously, bad monetary policy.
The Psychology of Perpetual Inflation
Here's a revealing data point that rarely makes headlines: even during periods of genuine deflation, surveys consistently show that people feel prices are too high. This isn't irrational — it's a deeply human cognitive pattern. Our minds are wired to register losses and costs more vividly than gains and savings. We notice the egg carton that costs more; we rarely notice the television, the airline ticket, or the piece of clothing that costs less than it did five years ago.
Economists call this the stagflationary mindset — a persistent psychological state in which consumers simultaneously feel squeezed by prices and stagnant in wages, regardless of what aggregate data shows. Understanding this bias is the first step toward making clearer-headed financial and investment decisions, rather than ones driven by emotional anchoring to the most visible price increases.
The Real Driver of Inflation Is Not What You Think
When oil prices rise or tariffs are imposed, the instinctive response — from consumers, commentators, and unfortunately some central bankers — is to declare an inflationary emergency. But this conflates relative price changes with monetary inflation, and the distinction is fundamental.
Inflation, at its structural core, is a monetary phenomenon. Prices rise broadly and persistently not because a specific commodity becomes scarce, but because the quantity of money circulating in the economy increases faster than real output. And here's the part that surprises most people: the majority of money creation doesn't happen at the central bank — it happens at commercial banks, every time they issue a loan. Credit creation by private banks is the primary engine of money supply expansion, and therefore the primary engine of sustained inflation.
When lending growth weakens — as it has in the current environment — the monetary fuel for broad inflation dries up, regardless of what oil prices or import tariffs are doing. Supply-side price shocks cause pain and redistribution, but they don't generate the self-reinforcing monetary dynamic that constitutes true inflation. Consumers facing higher energy costs cut spending elsewhere, which depresses demand across other categories and creates offsetting deflationary pressure. The net macroeconomic effect is far more muted than headlines suggest.
Central Banks Are Fighting the Wrong Enemy
This brings us to what may be the most consequential analytical failure in current policy circles: central banks have a well-documented historical tendency to react most aggressively to potential supply-side inflation, even when underlying demand is weak. The European Central Bank has already signaled potential rate hikes in response to oil price trends — despite demand conditions that don't support inflationary momentum. The Federal Reserve, meanwhile, recently upgraded its growth forecast even as real-time GDP and employment data signal deceleration.
This is what happens when institutions operate from models rather than ground-level economic reality. The risk isn't that central banks are unintelligent — they are not. The risk is institutional: sophisticated theoretical frameworks can create systematic blind spots, leading policymakers to tighten into weakness and potentially trigger the very financial stress they are trying to prevent. A central bank that raises rates based on an inflation forecast that never materializes hasn't stabilized the economy — it has damaged it unnecessarily.
The Iran Wildcard — and Why the Policy Response Matters More Than the Conflict
Geopolitical tension involving Iran is a genuine source of uncertainty. But history offers an instructive corrective to worst-case thinking. During the Gulf War, the Ukraine conflict, and other major Middle Eastern flashpoints, crude oil spiked sharply — and then retraced to pre-conflict levels, often within months. Markets and consumers adapt faster than crisis narratives allow. Iran itself has historically moved toward negotiation once economic pressure reaches critical thresholds.
The greater economic threat isn't the conflict. It's a central bank that mistakes a temporary supply shock for entrenched monetary inflation and responds with policy tightening into a softening economy.
The broken compass is more dangerous than the storm.