Morici: Why central bankers are so confused by low prices

Central bankers are captive to conventional economics – faced by low inflation and low unemployment they are flummoxed about pulling back on monetary stimulus.

Their dilemma lies in an incorrect reading of statistics and taking modern macroeconomic theory too seriously.

Unemployment in the European Union is at its lowest level since 2009, yet inflation across the pond drags along at about 1.3 percent. U.S. unemployment is at a similar trough, while headline and core inflation remain well below the Fed’s 2 percent target.

According to the textbooks, unemployment and inflation are supposed to move in opposite directions, not in tandem as they have. As summarized by the Phillips curve, falling unemployment should coincide with tightening labor markets and rising wages and prices, and the inverse should be true as unemployment rises.

For one thing, headline unemployment rates are proving an increasingly poor measure of what is going on in many labor markets. In the United States and Europe, large numbers of adults are on the dole and opting out of work altogether, and on both continents many university graduates are underutilized in low-paying jobs – serving coffee at Starbucks, chaperoning tours of historic venues, and the like.

For another, macroeconomic models deal poorly with the fact that entitlement programs have created large pools of contingent workers – folks who may only again participate in the labor force if wages rise very sharply. More generally, those models paper over other demand- and supply-side structural changes that are holding down prices and subverting the historically expected inverse relationship between unemployment and inflation.

Central bankers point to low oil prices, instigated by the U.S. shale revolution, but those fell last year to about to US$44 a barrel in 2016 and generally have been a bit higher in 2017.

Janet Yellen is fond of pointing to falling cell-phone subscription rates – thanks to more intense competition among the four principal carriers. However, even after pulling cell-phone services out of the core deflator for personal consumption – the Fed’s preferred measure of inflation – price increases have been slowing through 2017 and were only 1.6 percent in June.

The cell-phone alibi looks even weaker after considering recent weakness in inflation for apartments, air fares, autos, and apparel. All are items that should exhibit more robust price increases this late in the business cycle but in varying measure, their prices have been dampened by swelling capacity and innovation that push down costs and retail prices.

Perhaps the most compelling phenomena have been the intersection of overbuilding in the retail sector – everything from grocery to department stores – and the revolution in supply-chain management and increased competition associated with the Amazon effect.

Internet aggregators are driving down supply-chain management costs and prices for many household items and business necessities. With their share of retail at only 8.5 percent but growing, that downward pressure on inflation is not likely to abate soon.

Wal-Mart and Amazon are in unique positions owing to the former’s mass and the latter’s unique access to consumers’ attention – most online product and price checks begin at the Amazon site these days – to drive down suppliers’ margins. In turn, suppliers push back on workers’ wages and producers of basic materials or in the case of manufacturers in China, they can rely on generous credit conditions and subsidies that permit selling at or near a loss. Similarly, shifts in consumer preferences are diminishing the pricing power of major consumer- product companies like Kraft Heinz, Procter and Gamble and colleges. Consumers are getting smarter about the false monopoly premiums once demanded by many consumer brands and educational institutions.

These kinds of structural changes – all occurring with increasing perforce – simply shift the parameters of the Phillips curve in ways conventional macroeconomic models and the bubble think at central banks cannot accommodate.

In many ways, the latter mirrors the obsession central bankers have with trying to inflict inflation on households. Having observed that inflation in the past has accompanied economic growth (and lower unemployment), in a fit of ill-logic they have concluded that at least 2 percent inflation is necessary to accomplish steady growth.

The steady growth in the United States and recent uptick in Europe indicate that simply isn’t so, and central bankers should normalize monetary policy now.

Peter Morici is an economist and business professor at the University of Maryland, and a national columnist. © 2017, The Washington Times.

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