You can be excused for thinking economists are crazy. With food prices rising, how can they be worried inflation is too low?
The latest data confirm what many consumers already know: Certain types of food are getting considerably more expensive, with beef prices up 7.4% during the past year and eggs up 9.9%. The household pain doesn’t end there: Electricity costs rose 5.3% during the past 12 months and natural gas soared by 16.4%. The typical paycheck, meanwhile, has risen by just 2% or so.
Economists aren’t particularly worried about rising prices, however. Food and energy prices are notoriously volatile, and they’ve risen largely because of temporary factors. A bigger concern: Prices that are barely rising or falling, which can signal pernicious stagnation or worse.
Overall inflation is running at just 1.7% per year, below the Federal Reserve’s target of 2% annual inflation. Several big categories of stuff are getting cheaper, including clothes, furniture, appliances and of course anything related to computers. That might sound like good news for consumers, since lower prices suck less money out of your wallet. But falling prices could have a lot to do with the scarcity of jobs and raises, and the falling living standards many Americans are enduring.
A low-inflation warning
The International Monetary Fund recently warned that low inflation is slowing the economic recovery in Europe, Japan and the United States. Europe may be the biggest concern right now, since inflation is close to 0. In Greece, there’s even deflation, with prices falling about 1% year over year — which ought to illustrate how soft prices and a punishing economy go hand in hand. Japan, meanwhile, is recovering from its own deflationary spiral, with hope rising that it can sustain whopping price increases of 1% or so on many basics.
But even low inflation such as we have in the United States can harm ordinary consumers, in three basic ways. Low inflation usually means companies have very weak pricing power and can’t charge more for what they sell. That means revenue and profitability tend to remain flat, which in turn depresses hiring, since companies aren’t likely to boost payrolls if they don’t have extra revenue to cover the additional cost. That’s essentially what is happening now, with the unemployment rate still an uncomfortably high 6.7%, 3.7 million out of work for 27 weeks or more and the portion of adult Americans even interested in working falling sharply. When companies are able to raise prices, by contrast, they have more money and usually spend some of it on new hires.
A reasonable amount of inflation also helps people pay down debt more easily. When you take out a loan to buy a home or car, your monthly payment usually stays fixed and doesn’t rise with inflation. But your income usually does rise with inflation (or ought to, in a healthy economy). So your $300 monthly car payment or $1,500 mortgage installment will take a smaller and smaller chunk of your paycheck if your income rises by 3% or 4% every year. Without inflation to push up incomes, consumers don’t get that advantage.
Low inflation also gives consumers the option to put off purchases with no fear they’ll have to pay more in the future. That’s nice for shoppers, but consumer spending — which powers the economy more than anything else — would be more robust if people knew they’d save a few bucks by buying today rather than tomorrow. This has been a particular problem in Japan, where deflation actually created the incentive to put off purchases as long as possible in order to get the best price. That has contributed to two “lost decades” of stagnation.
Inflation can obviously be a problem when it exceeds a manageable level — say, 4% — and begins to erode consumers’ purchasing power. That’s what happened in the late 1970s, when inflation hit double digits, sent interest rates soaring and triggered a double-dip recession.
Critics of the Federal Reserve have been insisting since 2008 that another era of ruinous inflation is on the way, on account of the aggressive easy-money policies the Fed has pursued to end the recession and turbocharge the recovery. There are two basic reasons inflation hasn't soared. First, the money the Fed has “printed” hasn’t really begun to circulate in the economy, because the banks that have it are reluctant to lend it out. Most of that money remains parked in accounts at the Fed itself. In fact, most economists think lending standards these days are too tight, not too loose.
Second, wages are barely rising, since there’s an oversupply of labor in many parts of the economy. Labor is still a major cost for most companies that sell products or offer services, and with those costs stable, there’s little economic need for companies to hike prices — especially with thrifty consumers allergic to higher prices.
The savage irony is that consumers feel the sting of higher prices on things they need every day — namely, food and energy — while also bearing the intangible cost of price declines that are holding back the overall economy. A little more of the right kind of inflation would represent a better deal.
Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.
- Personal Finance - Career & Education
- Banking & Budgeting