Disinflation is here: But it's not the kind we want!
In recent economic discussions, we've often encountered the concept of "sticky" consumer prices and the legacies of disinflation. On the surface, the prospect of prices falling may seem beneficial for individual consumers. After all, who doesn't appreciate a little relief on their wallets? However, the context surrounding these changes in consumer prices often signals more profound issues within the broader economic landscape.
What are Sticky Consumer Prices?
In economics, the term "sticky" refers to prices that are slow to change in response to shifts in the economy. This concept traces back to the writings of John Maynard Keynes, who posited that certain prices don’t adjust instantly to reflect new economic data. For instance, the price of household furniture doesn’t typically fluctuate each month. On average, it might only adjust every six months. This delayed reaction means that some prices are influenced by past economic conditions rather than current realities.
A Closer Look at Disinflation
When we discuss disinflation, we're talking about a decrease in the rate of inflation. It's crucial to note that disinflation is different from deflation, which is a drop in overall prices. Disinflation refers to prices rising at a slower pace, which many perceive as positive at first glance. The price of goods isn't skyrocketing as fast, making them moderately less expensive over time.
However, the comforting veneer of disinflation doesn't always tell the whole story. When disinflation stems from declining demand rather than increased supply, it's a red flag for potential economic trouble. Lower demand often indicates that consumers aren't spending as much because wages aren't keeping up with the overall cost of living. Thus, while the headlines might celebrate falling prices, the experience for many individuals is tighter budgets and stagnant earnings.
The Role of the Federal Reserve
The Federal Reserve's response to these trends also merits discussion. One crucial aspect is their handling of interest rates. In scenarios of disinflation, the Fed might resort to rate cuts, aiming to invigorate economic activity by making borrowing cheaper. Yet, these rate cuts often come across as emblematic efforts—an attempt to demonstrate action in the face of economic shifts rather than an assured strategy to avert deeper issues.
The Fed's actions can sometimes appear as though they're attempting to “excuse” unanticipated economic outcomes. They might argue that unforeseen events, like natural disasters, impaired their goals, but assert that they did their due diligence. Nonetheless, such explanations often fall short of addressing the roots of sluggish economic performance.
The Bigger Picture
While media discussions frequently frame slow consumer price changes as indicative of underlying economic fundamentals, it's essential to specify what those fundamentals signify. Currently, the continuation of sticky consumer prices in combination with disinflation speaks to a demand-driven phenomenon. Consumers are either unwilling or unable to spend at levels sufficient to fuel growth due to a lack of wage increases or decreased working hours.
In the end, while sticky prices and disinflation might receive praise in some quarters, they frequently portend underlying economic vulnerabilities. A holistic examination reveals the need for more than simple price metrics to comprehend an economy's health. Sustainable economic recovery requires that growth be driven by robust demand supported by equitable wage growth, rather than reliance on temporary price deceleration. As wages rise and incomes improve, consumer spending can become the catalyst for a healthier and more balanced economic resurgence.
Here’s one of our favorite guys - Jeff Snyder - explaining this phenomenon.