Inflation Isn't Too High; It's Too Low

After all these years of modest price increases, a lot of Americans still can’t get used to two big ideas. One is that inflation really is low, despite your impressions as a shopper that everything seems to be getting more expensive. The other is that inflation can be too low. It seems illogical: Why would anyone ever want to pay more for stuff?

The truth is that inflation really is low when you take into account everything that you pay for, not just the items that are jumping in price (such as Manhattan real estate and meat). The Consumer Price Index rose just 1.1 percent over the 12 months through February. That’s based on prices collected by surveyors for the Bureau of Labor Statistics, a federal agency that is strictly nonpolitical.

It’s even harder for a lot of people to grasp the idea that inflation this low is a problem. One reason low inflation is bad is that when prices don’t go up much, workers’ pay generally doesn’t either. It so happens that average hourly and weekly earnings have done pretty well over the past year (rising 4 percent and 3 percent, respectively), but that’s probably not sustainable, since employers won’t forever keep raising their workers’ pay faster than they raise what they charge customers.

Second, a certain amount of inflation is good for employment because of what economists call money illusion. When demand is slack, employers tend to want to cut their real wage expenses. They can do that quite easily in times of moderate inflation just by handing out raises that are lower than the rate of inflation. But if inflation is superlow, employers would have to cut pay outright to reduce their real wage bill. Workers naturally hate that, so employers take the easier but arguably crueler way out by laying off workers.

The third reason to worry about low inflation is that it can tip into outright deflation. That’s when prices are falling consistently, across the board. Deflation discourages consumers from buying because they figure they can get things cheaper if they wait. It also increases the burden of debt, because the amount you owe doesn’t change even though your wages are falling along with everything else.

Central bankers have settled on 2 percent inflation as about right, but they keep missing, like archers who for some reason cluster all their arrows on the left side of the bullseye. You might think the solution would be to point their arrows a little more to the right, but the Federal Reserve and the European Central Bank, to name two, have been reluctant to take more extreme measures to stimulate growth and raise inflation, fearing that they could create asset bubbles and possibly cause inflation to become too high—i.e., miss on the right side of the bullseye.

Today, Bloomberg News reported that euro-area inflation slowed in March, by more than economists forecast, to the lowest level in over four years. Consumer prices rose just 0.5 percent over the past year, well below the 2 percent target.

“Zero-point-five percent is not where any central bank in its right mind would want it to be,” Chris Scicluna, head of economic research at Daiwa Capital Markets in London, told Bloomberg.

Here’s a piece about the problem of low inflation that I wrote last year, when Ben Bernanke was still chairman of the Federal Reserve. Now Janet Yellen has the job. But the challenge hasn’t changed: Inflation, contrary to what you may think on your next visit to the supermarket, is simply too low.

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