Inflation isn’t exactly a hot topic these days, although the lack of it might be. Despite aggressive monetary policy by the U.S. Federal Reserve (Fed) since the Financial Crisis, prices are relatively flat. Along with increased money supply, a generally healthy economy and an improving employment picture would suggest higher prices. So why is inflation depressed?
Inflation is defined as a sustained increase in the general level of prices for goods and services. Basically, inflation happens when too much money is chasing too few goods or services. While the Fed’s bond buying operations since 2009 have dramatically increased the amount of money in circulation, most of it has not reached consumers who would be most likely to spend it. Instead, much of the cash generated by the Fed remains with large commercial banks that are unwilling to lend.
Steep losses tied to easy lending standards caused bankers to clamp down on loan issuance after the housing bubble burst. Credit standards are finally starting to loosen, but many banks remain conservative when it comes to issuing new loans.
Another factor that may be preventing more money from reaching consumers is tied to legislation introduced in 2008 that allows the Fed to pay interest on excess bank reserves. Historically, bank reserves held at the Fed did not earn interest. A lack of return on reserves motivated banks to put their excess capital to work by issuing new loans. However, now that banks can earn a very safe return on their reserves with the Fed, they are lending less. While historically there has been a strong correlation between the US monetary base and inflation, that relationship has weakened following the new legislation. From 2005 to 2015 while the monetary base rose at an annual rate of 17.8%, inflation expanded by only 1.9%.
But banks aren’t the whole picture. Oil prices, which comprise roughly 8% of the Consumer Price Index (CPI), have plunged since July 2014. Excluding oil and food, core CPI was actually up about 2.2% year-over-year in July. But this is still below the long-term inflation average of 3.8% since the end of World War II.
Many argue that recently healthy jobs gains should fuel demand for goods and services and thus push prices higher. While it’s true that the U.S. has added an average of 3 million jobs in each the last two years, consumers have only recently started to loosen their purse strings. Since the Financial Crisis, many have instead focused on saving and paying down debt. At the same time, flat wage growth has hindered spending. But this is starting to reverse and the combination of high employment levels and now rising wages should support consumer spending and in turn, could add to upward pressure on the inflation rate. Of course, for inflation to pick up substantially would require accommodating increases in the money supply from the Federal Open Market Committee.
Finally, weaker global economic growth and a strong U.S. dollar have been headwinds for domestic inflation. Our economy is one of the strongest in the world and the U.S. dollar has appreciated compared to many other currencies as a result. This means that foreign currencies have declined relative to the U.S. dollar and the prices of imported goods are getting cheaper. In order to compete with foreign goods, domestic companies have generally lowered their prices, putting downward pressure on inflation. This phenomenon is known as “importing inflation”.
While there may be other factors responsible for low inflation, it’s worth noting that the current environment is generally positive for consumers and investors. Low, but steady inflation levels – all else being equal – means lower grocery and gas bills, as well as higher real investment returns. Inflation is often one of the biggest headwinds to achieving adequate portfolio returns. Rising prices can eat into an investor’s real return and delay the achievement of financial goals. But in this low-yield environment, low inflation is a benefit to investment portfolios which will have a better chance of delivering returns that outpace prices for goods and services.
To be sure, the current low-inflation environment may not last. As with many trends, inflation may return to average or even above-average levels in the future. We are starting to see wage income rise, consumers have increased their spending levels recently, and oil prices have rebounded year-to-date. Rising inflation can erode portfolio returns and spending power, but modest, steady price gains are also associated with healthy economic growth in which consumers are spending, businesses have pricing power, and wages are growing.
Carrie A. Tallman, CFA
Director of Research
Interesting Tidbit On Unclaimed Property
More people than you might expect are owed money and don’t even know it. Many different types of assets are escheated to the state for a variety of reasons. An individual might move – perhaps several times – and forget to update his or her address with all vendors. Funds may then be mailed to a previous address and subsequently be returned to the sender. The company will usually attempt to locate the individual; however, unclaimed funds will eventually be surrendered to the state. Alternatively, when family members pass away, assets are often left unclaimed or not cashed, so they are returned.
I have used the below website many times while working with clients or estates. Take a couple of minutes to check it yourself. Maybe you will find only enough extra cash for an ice cream cone, or perhaps it will be enough for a vacation. It is very easy to claim your cash.