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The balancing act of inflation and deflation | The Triangle

The balancing act of inflation and deflation

Overall inflation (the combined finished goods and service inflation) in the United States’ economy has been below the 2 percent target since 2008. Attempts to inflate prices through rounds of quantitative easing to avoid falling in the deflationary trap have not produced the desired results. While service inflation just started to tick up since 2008, the goods inflation has followed a bell-shaped trajectory.

If an economy falls into a deflationary trap, it will be difficult to climb out of it. Japan has spent two decades in a deflationary trap. New technologies, robots, high unemployment, low wages and a glut of commodities, particularly oil, have worked together to keep inflation below target in the U.S. and other countries.

Last month’s jobs report shows that the unemployment rate has reached 5 percent, which is the lowest rate in six years and is very close to the Fed’s estimates of the 4.8 percent full employment unemployment rate. Moreover, the wage rate increased by 2.5 percent in that month, which is greater than the 2 percent that has prevailed since the Great Recession.

Labor is a service and a factor of production. Thus, it is an important ingredient in producing many services such as information, transportation, insurance, healthcare, telecommunications, banking, real estate, legal services, advertising, employment services, waste collection, computer training, etc.

The service sector is more than 70 percent of the U.S. economy, and correspondingly the service inflation is about two thirds of the overall U.S. inflation. The service inflation has recently been rising and the U.S. Bureau of Labor Statistics considers it the best gauge of inflation. This inflation is expected to spill over to the goods inflation and also increase inflation expectations which have been anchored since the 2008 global financial crisis.

This assertion of rising service inflation and ensuing possible increases in inflation expectations have many implications for the U.S. economy, ranging from changes in interest rates (including mortgage rates) to consumer prices to exchange rates. Expected inflation increases interest rates, which in turn affect financial spreads around the world, and also impacts exchange rate differentials, which all affect general consumer prices.

Research should be done on understanding the time lag it takes for service inflation to manifest itself in the overall inflation. The longer the lag is, the better the adjustment of the economy to a stable inflation environment will be. It is known that present inflation feeds on past inflation through changes in inflation expectations and it could get out of hand.

At this time, we should pay more attention to service inflation than to the consumer price index.