Inflation Is Weird Right Now

Though we don’t like the sound of it, prices aren’t increasing as fast as the economy’s overlords would like. We might need to thank globalization for that. 

What’s inflation again?

Inflation is when prices of goods and services increase along with a simultaneous decrease in the purchasing power of the dollar. This is caused, almost always, by increasing the money supply, or as we more commonly hear, printing more money.

There are two main scenarios that convince economists that a little bit of inflation is probably a good thing for the economy; both deal with our expectations.

  1. When consumers expect prices of goods and services to increase, they will be more inclined to buy sooner rather than later to avoid paying more in the future. This helps spur demand and keeps people buying stuff, which in turn requires people to produce more stuff. As a result, we get more jobs, higher wages (hopefully), more stuff, and an increase in the overall well-being of people in the economy.
  2. Conversely, when people worry that prices are going to drop, they hold off on buying the goods and services. The “virtuous cycle” of the first scenario turns into a downward spiral where prices actually fall, businesses reduce inventories, unemployment increases, and economic growth basically stops in its tracks.

Though there are a bunch of economists that can poke some serious holes in this logic, for this exercise, let’s just stick with what the bulk of mainstream economists believe about inflation.

What’s happening today

In order to avert a downward spiral in 2008, the Fed has been injecting cash into the money supply ever since. On the surface, this practice seems to be working, kinda. The stock market is roaring (though, a recession is surely on the way). Unemployment is at the lowest point in 17 years (but so is the labor force participation rate). The recent job growth is a testament to a pretty healthy economy as well. (The Beveridge curve, which shows the ratio between job vacancies and unemployed workers, is displaying that for every 1 job opening there are 1.075 unemployed workers. This is the best it’s been in a long while.) Enough of my parenthetical digressions.

 

beveridge curve
Job Opening and Labor Turnover Highlights July 2017

 

However, even with the cash injections, the rate of inflation is making Fed economists squirm in their leather office chairs. And, they should be! They’re slightly up a creek without a paddle. According to a new Fed report, people aren’t expecting prices to increase anytime soon. This is the main reason the Fed is so cautious to increase the Fed funds interest rate and/or start shrinking the money supply. Though a bit counterintuitive, when prices go down, so do our paychecks. Ain’t nobody okay with this, though I’m sure some economists would be. 

No one really knows why this is happening. But, misidentifying why it’s happening and going about it incorrectly could really screw over many of the Trump supporters who haven’t seen much of the economic recovery.

Globalization: It’s complicated

As mentioned in a parenthesis, one reason could be that even though unemployment levels are down, there are still a whole bunch of folks who are working part-time involuntarily. Additionally, the labor force participation rate is lower than before the crisis. This slack in the labor market keeps wages from growing as well. If wages stay stagnant, inflation stays stagnant as well. This is probably the most popular theory behind slow inflation.

Another reason is a little more complicated — globalization is to blame. Goods and services have different rates of inflation in today’s modern economy and are affected differently by globalization. For services, say haircuts, these are produced and purchased locally. Barbers in New York City only compete with barbers in New York City. On the other hand, goods, say hats, can be produced anywhere and purchased all around the globe.

Over the past year, prices for goods have risen 0.3 percent, while prices for services have gone up by 2.3 percent. This also translates to the worker as well. Wages have increased more for workers in service industries than they have for workers in the “goods” industry. Particularly because it’s easier to just move production to where there are cheaper employees — such as China, India, or virtually any developing country.

A third stagnant inflation theory is that Fed officials started considering the fierce competition in the cell phone market. Prices have dropped substantially in the last year for both cell phones and the service plans. Adding this new info into the data has overestimated how slow inflation really is. Nobody is really complaining about the lower prices, that’s for sure.

Changing landscape = uncertainty

In any case, inflation is a huge indicator of the health of the economy, and thus, our own economic well-being. The changing landscape of the modern economy involves a push and pull between goods and services, thus making the whole question about inflation rather murky.

Asset prices, like home values and the stock market, seem to be flying high. But, the labor force is weird and wages are slow. As the economy continues to experience the ebb and flow of automation and globalization, Fed officials will have their work cut out for them.

Let’s hope they get it right.

 

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