The Federal Open Market Committee raises or lowers interest rates to help keep inflation near a 2% target, which is the rate believed to be consistent with the Federal Reserve’s dual mandate to seek stable prices and maximum employment. According to the personal consumption expenditures (PCE) price index — the Fed’s preferred inflation gauge — core prices (excluding food and energy) rose just 1.6% year-over-year in June 2019, even though the unemployment rate was sitting near 50-year lows (3.7%).
In the past, tight labor markets have paved the way to higher wages and inflation. The last time unemployment was close to today’s levels (3.5% in late 1969), overall inflation was running closer to 6.0% and housing costs were rising even faster.
Low inflation may seem like good news, especially for cash-strapped consumers and retirees living on fixed incomes, but it has a darker side. Wage gains have also been weaker than expected, and lack of pricing power is often a reflection of a soft economy. When demand is tepid and/or profits suffer, companies that can’t raise prices may eventually cut spending — including payrolls — instead.
A combination of structural changes in the U.S. economy and global market conditions are helping to drive down inflation:
- Demographic Trends- Retiring baby boomers are largely being replaced with a much smaller generation of entry-level workers.
- Rise of E-Commerce- Websites and mobile apps connect buyers to sellers regardless of proximity, increase the visible supply of available goods and services, and facilitate price comparisons so consumers can choose less-expensive options.
- Growth Slowdown-An aging population and advanced technologies are changing how people work and spend, and these longer-term trends may continue to dampen inflation in the coming years. More recently, trade disruption and slowing U.S. and global economic activity have been causes for concern.
On a positive note, the absence of price pressures may enable the Fed to keep interest rates low for a longer time without sparking runaway inflation. But policymakers could be surprised by the path of inflation in the coming months. For this reason, it might be wise to have a financial strategy that takes a range of economic conditions into account.