Why is inflation so low?

Jan 2, 2016 by Adam Powell

Inflation examines how the price of a basket of goods changes over time. Inflation is an invented construct, and can be calculated in multiple ways, as different baskets of goods can be used. For instance, in the Consumer Price Index for all urban consumers, housing as roughly 42% of expenditures. In the unadjusted Personal Consumption Expenditure (PCE) price index, housing accounts for 27% of expenditures. Individuals have differing tastes in the baskets of goods that they consume, and thus will experience different rates of inflation than the stereotypical consumers used to calculate the indices. Likewise, non-smokers will not experience the impact of changes in the price of tobacco, although tobacco is one of the goods included in the indices.

In addition to differing tastes, consumers face differing price exposures. While some goods, such as motor vehicles, tend to be priced uniformly across the country, others, such as housing, are not. As housing cannot be traded between regions, there are substantial regional differences in cost of housing which exist. As housing costs are rising in some areas faster than others, people in those areas are experiencing more overall housing-related inflation than the national average. As of November 2015, the trailing twelve month rate of PCE inflation was only 0.4%, and the Trimmed Mean PCE was only 1.7%.

	6/15	7/15	8/15	9/15	10/15	11/15
PCE	0.3	0.3	0.3	0.2	0.2	0.4
PCE excluding food & energy	1.3	1.3	1.3	1.3	1.3	1.3
Trimmed Mean PCE	1.7	1.6	1.7	1.7	1.7	1.7

From http://www.dallasfed.org/research/pce/

What this table shows, among other things, is that there are multiple inflation rates. The rate given is highly dependent upon the assumptions used to calculate it. The Consumer Price Index, calculated by the Bureau of Labor Statistics (BLS) has been calculated using multiple means over the past several years. As circular as it may seem, inflation may be low in part because the formulas used to calculate it have been revised to keep it low. Likewise, the monetary policy of the Federal Reserve impacts the inflation rate. While inflation is a product of the balance of supply and demand, there are levers which can be used to shift it. A low rate of CPI inflation decreases the government’s obligations to pay cost of living adjustments on Social Security and payments on Treasury Inflation-Protected Securities (TIPS) bonds. Why is inflation so low? In short, because efforts have been made to engineer it.

Let us close with a quote from the Federal Reserve’s December 16, 2015 press release: “Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports.” Thus, the Federal Reserve sets objectives for the inflation rate, but does not have complete power to achieve them.