September 15, 2017

Is Inflation Dead, or Just Resting?

Bruce Yandle

Distinguished Adjunct Fellow

America's low unemployment rate and decidedly-mild wage and price data have caused inflation worriers to rethink their estimates for the next round of interest rate increases. For a while, the bet was on this month, but that seems to have faded. Then, it was December. But from the way things look, the Federal Reserve, in its effort to protect us from inflation, will have a hard time justifying an end-of-year rate increase.

In deciding to raise rates, the Federal Reserve keeps one eye on wage increases, along with other data. It gets worried when the annual rate of increase exceeds 2.5 percent. The other eye is focused on the GDP deflator produced by the Department of Commerce. The Fed gets nervous when this index rises above a 2.0 percent annual rate.

As luck would have it, both measures are sending benign signals. According to the Bureau of Labor Statistics' August employment report, wage increases are running steady at 2.5 percent; the Commerce Department's most recently announced GDP deflator is increasing at just 1.4 percent annually.

But with the headline unemployment rate resting at 4.4 percent and the rate for bachelor degree qualified workers holding at 2.5 percent, why aren't wages rising? And why aren't we beginning to see worrisome inflation? Part of the answer is seen in the price of oil. The world's supply curves are shifting to the right. Energy prices are the driver.

The Fed's global all-commodity price index and comparable data for West Texas crude oil move together. Crude oil prices have fallen by 50 percent since the 2014 fracking revolution, and movement of the all-commodity index has taken a similar path. Energy, a significant input for producing other commodities, has kept a lid on commodity price increases.

Here's what that means for labor and wages. A large part of the working population drives to work each day. Falling gasoline prices increases the supply of labor and helps to hold down the cost of hiring workers. Movement of the Department of Labor's Cost of Hiring Index, which includes wages, salaries, and fringe benefits, has been holding steady at around 2.2 percent annually for a year.

We should also consider two other inflation-fighting forces when trying to understand why we see so little upward movement in the price level. First, since 1959 there has been a large domestic U.S. migration from the higher cost-of-living Northeast and Midwest to the lower-cost Southern states. Today, there are more people living in the South than in the Northeast and Midwest combined. The resulting relocations have delivered lower-cost goods and services.

And second, the 2010 advent of smart phone technology has connected some 6 billion people to the internet and to each other. The result? More competition and increased availability of the ultimate resource: creative human beings and what they produce.

Does this mean that we no longer need worry about inflation? Unfortunately, the answer is no.

There are still limits on how much can be produced in a given time period, and the economy seems to be riding close to those boundaries. But it takes more than bumping against limits to get inflation. Inflation is the result of more money chasing a limited supply of goods. And the Fed controls the printing press.

No, inflation is not dead. It's just resting.