Inflation Is Dead: What’s Needed to Reanimate It?

Art by Wesley Allsbrook

Inflation: R.I.P. The goal of the Federal Reserve and other central banks is to resurrect inflation, getting it above 2% annually. Good luck with that.

What would it take to bump inflation back to life—that is, above 2% yearly? Surging population growth with young people vastly outnumbering retirees, emerging market labor costs on a par with those in the West and Japan, and technology advances reaching a place where it’s not displacing any more workers. Oh, and perhaps a return of labor unions.

And that’s why low inflation stands a good chance of sticking around for the next 10 to 15 years. This is how long Harvard economist Lawrence Summers expects very, very low inflation to last. Speaking at the Peterson Institute for International Economics in April, he said “the 2% inflation target will not be attained anytime in the next decade.”

Powerful influences are at work to hold down inflation. At present, the US population and those of developed nations are growing older. A sudden explosion of births or a massive influx of immigrants could make up for that. Neither is likely soon.

Someday, places like Vietnam, which makes manufactured goods at a fraction of what American factories do, will be on a wage par with the US. That will take a while. And on our shores, technological disruption of the traditional business landscape keeps grinding away: Airbnb threatens hotel jobs and bookings, Uber is hurting taxi employment and revenues, on and on. Upshot: The downward pressure on wages and prices will be inexorable for some time.

Inflation has lagged for a long while. The widely used Consumer Price Index (CPI) has been consistently below 2% for the past 10 years. For May, compared to 12 months before, it was up 1.8%. The Fed prefers a broader measure, called the personal consumption expenditures price index, or PCE, which shows inflation is even lower, at 1.6%. By whatever yardstick, inflation has had a tough time breaching the 2% ceiling. In 2009, the latter part of the Great Recession, prices actually declined.


And some savants believe that, due to measurement difficulties, inflation is even less than the official levels. Maybe zero. Alan Greenspan, former Fed chairman, in an appearance at the Wharton School in April, said, “If you had a 2% inflation rate as currently measured, it’s actually the equivalent of zero, for what consumers are buying.” Technology advances are a big reason. Example: When traveling overseas, you can point your camera at a sign in a foreign language and it will translate the wording. Hiring a human translator would be more expensive.

Certainly, countervailing influences, like the current Sino-American trade conflict, can shift the trend to a degree, but it’s doubtful that the basic direction of US prices (lower) will be affected for the long-term. While an escalation in the trade war would jack up prices for Americans of Chinese exports, thus far lower prices on other items have more than offset the tariffs overall. If President Trump expands the reach of his levies to $300 billion more in China’s goods, the result may well be more painful. Before he hiked the current tariffs on $200 billion in wares from China, to 25% from 10%, one study estimated that the duties cost the average American household $414.

How Low Can It Go?

Why is low, low inflation bad? Moderate inflation, meaning higher than today’s, greases the gears of the economy. It’s a way to increase corporate profits with little effort. And when the Fed has to combat recessions, by lowering interest rates below inflation, the central bank has flexibility, which it wouldn’t have if inflation were zilch.

Inflation is quiescent because of factors that aren’t about to change for some time—barring the unforeseen. The 1970s hyper-inflation is a bad memory, and its equally evil twin, deflation, is unlikely unless the nation encounters a killer economic downturn.

The weakness of inflationary forces is seen in “the velocity of money, which is at historic lows,” said Ryan Nauman, the market strategist at Informa Financial Intelligence’s Zephyr unit. This means that people aren’t spending as much as they used to, and dollars aren’t turning over in the economy. Instead, folks are devoting cash to invest or reduce debt. This phenomenon, he noted, “is putting a lid on inflation.”

The so-called Amazon Effect seems to dampen brick-and-mortar retailers’ mark-ups. You can choose from a wider variety of goods than a physical store offers, and get them delivered fast online. A study by Alberto Cavallo, a Harvard Business School professor, describes how Amazon and its digital brethren fine-tune pricing to get the best advantage over the competition.

Measuring inflation in light of technology-induced pricing changes is daunting, according to a Brookings Institution paper by Brent Moulton, an economist formerly with the US Bureau of Economic Analysis. One thing is for sure: Tech has lowered a bunch of business costs, often at the expense of payrolls.

You can summon more information and receive more entertainment on your smartphone than was imaginable only a few years ago. You don’t have to trek to a library to look stuff up, or pay for movie tickets or cable subscriptions for diversion. How can one quantify such a sea change? Meanwhile, many of the jobs in automobile plants are done by robots, not humans. And corporate back office functions no longer require armies of clerks. “It’s more difficult to measure how technology has affected the service industry,” said Paul Eitelman, senior investment strategist at Russell Investments.

The Wage-Price Pull: A Faint Memory Now

Time was that the so-called wage-price spiral was a key impetus for inflation, and often the main one. Workers demanded higher compensation, management went along, and the price of their goods and services rose. Well, the wage-price spiral is extinct, as union clout has fizzled. Labor’s share of the national income used to be north of 70%. That has slipped to 66.4% in 2018.

In fact, real wages (that is, adjusted for inflation) have barely budged over the past four decades, a Pew Research Center study found. And lately, despite low unemployment and big demand from employers, real hourly earnings picked up only a bit, to 1.7% in May, year over year, the US Bureau of Labor Statistics indicated. A lot of that might well be one-time gains from a hike in states’ minimum wage. For weekly earnings, it was a more muted 1.3%. Big deal.

Although the labor market is tight, its internal dynamics negate labor demands for higher pay. For one thing, individual employees often count themselves lucky just to have jobs, remembering the nasty recession, and don’t want to antagonize the boss. And then comes the giant baby boomer generation’s exit from the workplace. “A lot of white-collar labor is retiring, replaced by lower-cost” younger people, said John Augustine, chief investment officer at Huntington Private Bank. “Blue-collar pay is up but not enough to move the needle.”

For inflation to recur in any meaningful way, Russell’s Eitelman observed, wage growth would have to exceed productivity increases. That hasn’t happened since 1973. Once upon a time, union membership was strong—at about a third of the workforce in the 1950s—and that has been cut to 10.3% as of last year, the Bureau of Labor Statistics finds.

Sparkplugs of Inflation Sputter

Certain parts of the CPI have had the greater impact on inflation through the years, and nowadays are mostly on the downswing.  Chief among them has been petroleum, at least since the 1970s Arab oil embargo. Oil had a peppy run early in this decade, when per-barrel prices topped $100. That ended in tragedy starting in 2014 and 2015, when excess supply and a Chinese economic pullback combined to tank prices to $32.

Since then, oil prices nudged back, only to drop again starting last year. This is owing to signs of a global economic slowdown and trade disputes. They even overshadow supply qualms spurred by recent attacks on oil tankers in the Gulf of Oman.

Other areas that historically have contributed to inflation are more muted of late. The housing meltdown that incited the Great Recession burnt housing demand to the ground. Housing, which was climbing at a double-digit pace before the financial crisis, was on the downswing for years until 2012, when it started to climb again. Over-building in some places and a drop in buyers, among other things, may have tamped that down. These days, the average home price rose just 3.6% in April, year over year, CoreLogic data show.

Buying a home is an enormous outlay for most people, and the more-stringent post-crisis rules have helped supress demand. Still, more people these days prefer to save their money than buy real estate. “The demand pull for housing” is diminished, Crit Thomas, global market strategist at Touchstone Investments, pointed out. Leading up to the crisis, quarterly mortgage originations were between 4 million and 5 million. After that, they’ve seldom topped 2 million.

Even college education, which used to see strong hikes in tuition and fees amid surging numbers of students, seems to be leveling off. Public complaints about education costs may have been a factor. Private colleges were up 0.3% in the current academic year, versus 5.9% for the 2009-10 period; and public colleges fell 0.4% in the 2018-19 year, compared to a 10.4% boost 10 years before, College Board figures indicate.

One area that still has an inflationary bias is health care, although indications have emerged of that tapering off. This sector’s prices have long ascended in excess of general inflation, courtesy of an ageing population as well as government and health insurers’ lack of pushback against the medical industry. In April, health insurance costs hit a five-year high, spiking 10.7% over the previous 12 months.

On the other hand, escalating drug costs, which both the Trump administration and congressional Democrats decry, may be succumbing to the political pressure. Amid talk of some kind of federal price controls, pharma costs should dip from 4.2% this year to 3.8% in 2020, the Premier health consulting group says.

Pick your data point, and it leads in the same direction: downward for inflation.

“Eventually, we’ll get ahead of 2% and inflation will normalize,” Informa’s Nauman predicted. But if people like Professor Summers are right, that won’t be for a while, say 2029 or 2034.

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