Is Inflation Over?

Consumer Prices Fall by Biggest Amount in Six Years

Is Inflation Over?
January 14, 2017

The November 2014 Consumer Price Index (CPI) fell by 0.3%, coming as a pleasant surprise to Wall Street analysts who were expecting a 0.1% drop. That change represents the largest drop in CPI since December of 2008, and adjusts the overall inflation growth over the last 12-month period to 1.3%.

Thus the trend of falling year-over-year inflation rates continues. In 2011, inflation growth was 3.2%. Since that time, inflation has fallen to 2.1% in 2012 and 1.5% in 2013. Without a December surprise, the final inflation value for 2014 will come in under 1.5%.

While plummeting gas prices are a major factor, they are not the only influence on an improved inflation outlook. Overall, the picture is mixed, with modest decreases in such items as apparel and used vehicles and slight increases in food and shelter. The Core CPI value (excluding food and energy costs) rose by only 0.1%, down from a 0.2% rise in October.

Is it time for the Federal Reserve to bring the lookout down from the crow’s nest and prepare to set sail in perpetually inflation-free waters? History and common sense say no. Think about the following factors:

  • Economic Recovery – While it has been a long time coming, the economic recovery is slowly affecting more than just the stock market. Job growth has been steadily improving (with an average of nearly 240,000 new jobs per month in 2014) and wages are finally beginning to rise.

    In other words, classic inflationary pressures should return once the economic recovery kicks into full gear – although that may take a few years to achieve. Consumers will have more money to spend, demand will outstrip supply on some items, and inflation follows.

  • Temporary Oil Prices – The current strategy of Saudi Arabia to overproduce and squeeze out oil producers with higher costs (e.g. U.S. shale oil) can only last for so long. Eventually oil prices will stabilize and then rise to a new equilibrium point, and the effect on the CPI and inflation will be significant. What goes down must come up….

    Meanwhile, those of us of a certain age are shaking our heads at the celebration of $2.00 per gallon gas prices, after years of $2.00 as a dreaded upward benchmark.

  • Actions from the Fed – Keep in mind that the Fed has two major economic mandates – to maximize employment while keeping inflation around a target value of 2%. Those goals do not always work in the theoretical lockstep that allows the Fed to make a simple adjustment and achieve its goal.

    Consider that for years, the Fed has been attempting to stimulate the economy through near-zero interest rates and injecting money into the economy through buying bonds and securities (the Quantitative Easing, or QE, programs). QE has finally ended, but at some point, the Fed is going to have to sell off some of its massive inventory of bond holdings and raise interest rates.

    The Fed must also guard against deflation, a situation where prices, demand, and wages all fall in a vicious cycle called a deflationary spiral. The Fed is not above inducing temporary inflation if needed to achieve other long-term economic goals.

A look at inflation rates for the past hundred years shows several periods of relatively low inflation only to see rises triggered by events (oil crises, wars, etc.) as well as general gradual inflationary pressures. Inflation is a fundamental part of economic systems. Do not overanalyze – just enjoy the low inflation rates while we have them, as they will not last forever.

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