On Wednesday, Federal Reserve Chairman Jay Powell said that he is concerned about low inflation not only in the United States but also in other developed countries. Specifically, inflation for a significant time period has remained below the central bank’s 2 percent target. The U.S. Labor Department reported that our inflation rate was 1.5 percent for the 12 months ending in February 2019.
The St. Louis Federal Reserve Bank’s announcement, “Why is inflation so Low,” provided some insight into the reasons for central bankers’ concerns. Very low inflation can morph into deflation. Deflation occurs when average wages and prices are declining. This situation is associated with weak economic conditions. During the Great Depression, 1929-1933, prices declined 7 percent.
Powell does not want America to head into Japanese-style economic conditions. Japan has been afflicted with low economic growth and high unemployment for 30 years.
For the most part, the Federal Open Market Committee (FOMC) has focused on personal consumption expenditures (PCE) because it covers a wide range of household spending. PCE excludes food and energy items.
Low inflation is not only a problem in the United States, but also in the rest of the world. Price levels for countries that are members of the Organization for Economic Cooperation and Development (OECD) for more than a decade have hovered between zero and negative. OECD includes many of the world’s most advanced countries but also emerging countries like Mexico, Chile and Turkey.
The St. Louis Federal Reserve quoted Alan Greenspan’s testimony before U.S. Congress in 2005: “The past decade of low inflation and solid economic growth in the United States is attributable to the remarkable confluence of innovations that spawned new computer, telecommunication, and networking technologies, which, especially in the United States, have elevated the growth of productivity, suppressed unit labor costs, and helped to contain inflationary pressures.”
In brief, Greenspan believed that technological advances lowered the price of goods that use new technologies intensively. Let me share with you several examples: Prices of television and photographic equipment have decreased 73 percent and 24 percent respectively since 2010. Also, higher labor productivity has been associated with a reduction in inflation by 2 percentage points.
The St. Louis Federal Reserve highlighted another phenomena that they call the “sharing” economy. Specifically, Airbnb and Uber, which are prime examples of the sharing economy, have increased productivity for the utilization of otherwise idle goods and services. This has led to a reduction in prices. Georgios Zervas, Davide Proserpio and John Byers reported that Airbnb’s entry into the Texas market reduced hotel room prices. Airbnb introduced about one-fourth of new hotel rooms. There are 13,587 medallions in NYC compared to 65,000 vehicles affiliated with Uber.
The concern over low inflation partially explains the most recent federal decision to hold interest rates steady for the rest of the year and end the monthly reduction of the Fed’s massive balance sheet in September.
Investors on balance are happy about the Federal Reserve’s plan to stop reducing their balance sheet. They believed that the Fed’s purchase of securities, called quantitative easing, helped stimulate financial markets and lower longer-term interest rates. Assuming the Federal Reserve keeps their balance sheet the same after September, then their balance sheet will be slightly more than four times the level it was before the financial crisis erupted in 2008.
I support fully the Fed’s current policy given that U.S. economic data has been mixed so far this year and economic growth abroad is slowing. Powell’s comment, “When the time comes, we’ll act appropriately,” is a pragmatic response to our current economic activity. The Fed expects the U.S. economy to expand at 2.1 percent this year, below its previous projections.
Originally published in the Sarasota Herald-Tribune
