Inflation
Lost in all the hyperventilation last week was news of our rate of inflation
There isn’t any. Or, rather, what inflation we have is small and getting smaller. Consumer inflation fell 0.2% in March largely due to falling energy and clothing prices. Even if we eliminate energy and food prices – notorious for their volatility – inflation only edged up 0.1% The biggest factor in the overall number was a 2.6% decline in energy costs, with gasoline leading the way with a 4.4% decline. Clothing costs fell 1.0% – the biggest fall in that category since April 2001. Food prices were unchanged largely because dairy prices fell, and the only substantial increase came in the used cars and trucks category.
The March figures bring inflation over the past twelve months to 1.5%, the lowest rate of change since last July. With the global economy generally slow, with US fiscal policy restrictive, and with the economy showing signs of slowing down, there is every reason to expect inflation to stay low. Indeed the more interesting question is why we haven’t experienced deflation – a period of falling prices.
The lack of deflation is perplexing. The economy has experienced a major contraction followed by an anemic recovery. Unemployment remains high by recent historical standards, and long term unemployment especially has emerged as a major concern. The economy still has significant slack in it and investment, while it has grown, is still insufficient to absorb corporate cash balances. Consumer demand remains weak, and private sector balance sheet adjustment continues, albeit it at a slower pace. These are the ingredients for a period of falling prices, but we haven’t yet seen such a phenomenon. Why not?
The answer probably consists, as is often the case, of many parts. The Federal Reserve Board has been pursuing what is, in most opinions, a very aggressive monetary policy. Right wing economists and their austerity advocating allies are stunned that the Fed’s activity has not produced rapid inflation – the fear of inflation has paralyzed policy makers for way too long – and so any discussion of deflation must appear surrealistic to them. Yet it seems clear that with the economy in its present semi-crippled state, and with demand so quiescent, no amount of ‘pump priming’ would cause an inflationary spiral. After four long years of loose money by the Fed accompanied by low and sometimes falling inflation, I think it reasonable to assume that right wing theories of inflation need to be tossed aside, or at least revised.
Then there is the phenomenon known as wage/price ‘stickiness’. This is a rather clumsy way of saying that regular folks have a hard time with lowering wages. That is, wages unadjusted for inflation. Since wages account for the most important aspect of the economy’s price structure, any movement in wages is often what triggers inflation – or deflation- overall. And, as we all know too painfully, wages are mired in a long term rut. So it is unsurprising that wage pressures are minimal, with the result that inflation is also minimal. But with long term unemployment remaining so high, and with the labor market remaining very difficult, it would be reasonable to expect wages to have fallen somewhat. That would make it easier for employers to hire workers, and would thus alleviate unemployment. Workers resist this adjustment. And this resistance results in downward ‘stickiness’ – workers are all too happy to see wages rise, but not at all happy to see them fall. Interestingly this resistance is to what are called ‘nominal’ wages – that is to say wages unadjusted for inflation. It applies less to ‘real’ wages – that is to wages after inflation is taken into account.
This downward stickiness in wages is a major psychological barrier to the onset of deflation. It is an example of the real world economy defying the rational thought processes that right wing economists like to assume drive economic activity. Don’t forget that economists examine the economy through the lens of relative price points, not absolute price points. That is they think in terms of ‘real’ prices not unadjusted or ‘nominal’ prices. So the models some economists use assume smoothly adjusting prices in both directions – both up and down. After all that is the ‘rational’ thing to expect. The evidence suggests that workers aren’t rational in this way, and thus, even in an economy with significant slack – high unemployment for instance – wages may not fall as those models assume, and we end up with prolonged very low inflation and not deflation.
Of course all this assumes that there is significant slack in the economy. This is another possible reason why we don’t see deflation. Perhaps there is less slack than we imagine. If so the downward pressure on prices that those economic models predict would be absent, and that absence would explain our inflation experience.
In any case expected inflation remains low, and possibly lower than the annual rate we saw through March.
