E Unpacking America’s Low Inflation Rate

There is a widely held assumption that with US wages on the rise, we should expect some cost-push inflation to materialize.

In fact, however, despite a record low 3.7% unemployment rate, it is very difficult to detect any evidence of cost-push inflation affecting consumer prices.

Indeed, and after picking up steam earlier in the year, consumer prices seem to be moderating again as evidenced by the core PCE inflation rate dropping in October to 1.8% year-on-year, or below the Fed’s 2% target.

(Core inflation in the US is measured by both by the core Consumer Price Index and the core Personal Consumption Expenditures price index. The Fed prefers to use the PCE price index because it provides a better indication of underlying inflation trends than the core CPI.)

Recently the US consumer price index (i.e. the CPI) remained unchanged in November from the October level due to a sharp decline in gasoline prices. As of the 12 months ending November, the all items CPI rose 2.2%, slowing from October's 2.5%.

Over the same 12 months ending November, the so-called core CPI increased 2.2% after climbing 2.1%.  

Nonetheless, as pointed out earlier in this article, the Fed’s favorite inflation target is the core PCE inflation rate, which dropped in October to 1.8% year-over-year, which is lower than the Fed’s 2% inflation target.

As the following chart illustrates, the core PCE’s more recent trends should be concerning to the Fed since the three-month annualized rate sank to just 1.1%, the lowest since May last year.

In unpacking the various factors that affect the rate of inflation, it has always been thought that for inflation to be sustained, it needs to be validated in the labour market.

However, since the great financial meltdown nearly ten years ago wage inflation in virtually in all advanced economies has been extremely low, despite the fact that the job markets measured by conventional measures, has tightened considerably in recent years.

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