With the world’s central banks again poised to enter an easing cycle, having scarcely begun to exit their last decade-long period of ultra-loose monetary policy, there is renewed talk of the risk of inflationary pressure. So far, despite historically extremely low interest rates and unprecedented QE for over a decade, official inflation measures have hardly ticked up, surprising many (ourselves included). It is clear that the new money has been going to asset markets, driving house prices and stocks to ever increasing heights, but those who have a hard time understanding exactly where the monetary stimulus has gone may be well served by taking a look at the below chart by Mark J. Perry, a scholar at AEI and a professor of economics and finance at the University of Michigan, who has deconstructed US inflation into sectors and compared them to overall CPI inflation.
The chart shows that while overall inflation in the two decades from 1997 to 2017 was 55.6%, there are massive variations across goods and services, with some sectors having seen significant deflation while others having seen up to 200% inflation.
We can draw several lessons from the chart, but to highlight five of the most obviously important:
- Inflation numbers like CPI are aggregates which tell a poor story of price rises faced by individuals with different consumption patterns.
- One major reason overall CPI is still low is that many sectors have a significant deflationary impact on the aggregate number. This is, essentially, capitalism working and offering consumers increased purchasing power, and it has an offsetting effect on monetary inflation (i.e. money printing).
- The “spectre of deflation”, so feared by mainstream economists (but rejected by Austrian economics), is not a spectre at all: some of the most thriving sectors, like technology, has seen up to almost 100% deflation over 20 years, but it has of course not led to the predicted absence of spending by consumers side-lined by an expectation of falling prices.
- Wage inflation is slightly higher than median inflation, meaning there has been only a modest real income rise for American workers.
- The red (inflationary) lines in the chart are broadly sectors with a high degree of government interference, whereas the blue (deflationary) ones represent sectors where the free market reigns relatively unimpeded. Healthcare and education (which we deal with here and here) are the clear outliers. The explanation is obvious: government regulation creates bureaucracy and cronyism drives prices higher to the benefit of incumbents and special interests, whereas competition and innovation drive prices down to the benefit of consumers.
Inflation is complicated and has confounded many economists, over the past decade in particular. Now that central banks are once again preparing to stimulate the world economy in an attempt to avert the inevitable downturn (this is already the longest expansion in recorded history), following decomposed inflation for individual goods and services rather than averages like CPI (which are heavily manipulated anyway) will give valuable insight into assessing when we will face a recession and how deep it will be.