Inflation could be a sweet double-whammy for the folks I call Solvent Seniors. Social Security benefits increase with inflation. For 2015 the increase was 1.7 percent. And if inflation is more than a feeble throb, interest rates may rise. Savers might actually earn a return on their money. Imagine that!
But don’t hold your breath. The prospects for both aren’t good. How come? Let’s take a quick tour of the numbers.
First, let’s check out the monthly and quarterly figures for the CPI-W, the Consumer Price Index for Urban Wage Earners and Clerical Workers. The Social Security Administration uses this index to figure the annual cost-of-living adjustment (COLA) for Social Security benefits. Today, things aren’t looking too good.
The CPI averaged 231.157 in the first quarter of 2014. This year the index is lower, not higher. It averaged 229.590 earlier this year. So we’re looking at zero inflation or modest deflation. If the COLA for 2016 were being set today, there wouldn’t be one.
But the real test will be in the third quarter. That’s when Social Security figures the benefit increase. The method is simple. The average CPI in third quarter of this year is compared with the CPI in third quarter of last year. If the index is higher than last year, there will be a cost-of-living increase.
The third quarter hasn’t happened yet, so we’re reduced to guesses. They could be intelligent guesses. Or dumb guesses. But either way, the third quarter is a guess.
Right now it’s looking like a bridge-too-far. In the third quarter of last year the index averaged 234.242. Now compare that to the index for the first quarter of this year, 229.590. Again, the current index is lower than the index in the third quarter of last year. The April CPI-W figure released last week, 231.520, doesn’t provide much hope.
By the third quarter the index must climb 2 percent just to avoid a deflation year. Then it would have to climb another 2 percent, to reach the inflation level the Federal Reserve is hoping to see.
Can the index climb to break-even or 2 percent inflation in only 6 months? Maybe. Maybe not. If it doesn’t climb 2 percent to zero inflation, 2016 will be another year without a Social Security benefit increase. Since automatic adjustments began in 1975 only two years had no increase, 2010 and 2011.
If the index doesn’t climb 4 percent to reach the target 2 percent level of inflation, interest rates may stay right where they are, as close to zero as possible.
Most of the financial media talk is about interest rates and whether they will increase. But that talk ignores an important fact: the Social Security COLA is more important to more people than higher yields. This isn’t a happy condition. But it reflects the grim reality that most people don’t have much in savings. (Last week I wrote about research showing that Social Security is more important to 90 percent of older households than savings, pensions or home equity.)
You can get an idea of the scale here by comparing amounts. This year Social Security will pay out about $760 billion in benefits. So a 1 percent COLA would mean about $7.6 billion more cash paid out to retirees.
Our banking system, in comparison, has about $12 trillion in deposits. An interest rate increase of 1 percentage point would put about $120 billion in new interest income in the hands of depositors. Households, of course, don’t hold all that money. And a lot of that money is in deposit accounts that seldom earn much interest, but we’re still talking about a lot of potential income for Solvent Seniors.
Would an increase in yields make a difference? You bet. According to Swiss Re, a major insurance firm, the current low interest rate policy cost American households about $470 billion between 2008 and 2013. Their report calls it what it is: “financial repression.”
Today a generation that learned to dread inflation after experiencing it in the 1970s may now hope for it. With apologies to Sigmund Freud, inflation will mean returns for the repressed.