Low Inflation: Good or Bad?

The plunge in oil/gas prices and lack of wage increases for U.S. workers keeps inflation low, but for how long? 

Today’s headlines herald low inflation. Sounds like a good thing, right? And yet there are rumblings about the prolonged period of low inflation being not so good. PNC POV asks Gus Faucher, PNC senior economist, to shed some light on low inflation and what it means for U.S. consumers and the economy.

POV:  What is inflation?

FAUCHER: Inflation is a broad increase in the price of goods and services. In the United States, we’ve had a period of low inflation for about three years. The topic is hot right now because all eyes are on the Federal Reserve which has announced its intent to increase interest rates when the inflation rate moves back up toward two percent from current rate of basically zero.

POV:  Isn’t low inflation better than rising inflation?

FAUCHER: The answer to that isn’t a clear yes or no because inflation will begin to notch up only when the U.S. economy grows significantly. As long as we have low inflation, it’s a sign that the economy has not fully recovered from the Great Recession.

POV: Can the economy grow without increasing inflation?

FAUCHER:  Not really. As the economy grows, more workers have jobs and spend more money. Goods and services are in greater demand. Businesses can hire more workers and raise prices because demand is strong. A broad increase in prices increases inflation. The good news about a bump in inflation is that it’s a sign of economic growth.  The bad news is that it will take more money to buy goods and services today compared to yesterday.

POV:  My dollar doesn’t stretch as far as it used to at the grocery store. How has that been low inflation?

FAUCHER: You’re right. The price of milk and other groceries has increased more than overall inflation. At any given time in the economy, some prices are going up and some going down. Inflation is the average price of goods and services in a month.

POV:  So my grocery bill went up. Does that mean other prices fell?

FAUCHER:  Yes. The price of some big-ticket items, like computers and large screen televisions, have remained flat or dropped. And inflation also takes into account quality improvements, like a cell phone that has more memory or a car that gets better gas mileage. But the plunge in energy prices is the big one impacting inflation.  You couldn’t have missed that drop at the gas pumps. But it also impacts the prices of other goods because the fuel costs tacked on to transport those goods to market dropped.

POV:  Should we expect this period of low inflation to disappear soon?

FAUCHER: That’s the million dollar question.  Inflation has stalled the past six months or so, primarily a result of the plunge in energy prices.  And there has been a temporary slowing in economic growth (Gross Domestic Product - GDP) in recent months. 

Overall, there is little pressure within the economy for businesses to raise prices. Again, part of that is the low energy costs. Another big one is that American workers are not seeing more in their paychecks. Remember, we need consumers to buy more to increase prices to kick up inflation. Workers won’t earnestly begin spending more until they start taking home more pay. There’s been a tiny glimpse of improving wages in the economic data of late, but very small change.

Bottom line, we are forecasting a strong rebound in economic growth mid-year – from April to September - and are not giving up on our forecast of real GDP growth this year of 3 percent.  This forecast is higher than our peers. We believe inflation will gradually pick up, to around 2 percent by early next year.

POV: Do I need to worry about low inflation?

FAUCHER: No. Inflation numbers are just one type of economic data that indicates the health of the economy. These indicators do not necessarily convey the experience of the general public. They are important signals to policy makers, like the Federal Reserve, who have an array of remedies at their disposal to speed up economic recovery process, including raising interest rates.  

Inflation can signal a "thriving" versus "striving" economy, says Senior Economist Gus Faucher

The U.S. Bureau of Labor Statistics tracks the prices each month of more than 70,000 items that Americans purchase. Included are the costs for housing, education, professional services along with an array of products that cost from a couple of coins to thousands of dollars. 

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