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Where is the inflation people keep talking about?

When most people think of inflation, they view it as a measure of the cost of goods increasing in price. And, with all that we have seen over the last few years, we would expect inflation to be rising faster than has been reported.

We have seen increased prices, after all, on almost everything: food, energy, insurance, healthcare, taxes and more. But we are still under the 2 percent inflation target that the Federal Reserve looks for as a healthy sign in the economy.

One big reason for this is that the Fed’s preferred measure of inflation, the core Consumer Price Index (CPI), is missing a key input, and that is wage inflation. Wages make up roughly 70 percent of the core CPI measure; so, since wages have stagnated over the last eight years, we have little-to-no inflation.

Many people find this scenario perplexing, as the simplistic correlation known as the Phillips curve is not holding true. The Phillips curve states that as unemployment goes down, inflation goes up. But this simplistic theory does not always work. We saw periods in the 1970s, for example, when inflation was high, and so was unemployment; but today’s environment does not reflect that era’s circumstances. Instead, we have had many years of job growth, to the point where the unemployment rate is roughly 5 percent, but inflation has not really gone up at all.

Unfortunately, we may not be seeing a dramatic increase in inflation, but there are many reasons why the Phillips curve or correlation to inflation does not seem to be working:

First off, demographics may be one cause of this lack of inflation. We are currently going through a demographic shift in our society, where the baby boomers, who were making large sums of money, are retiring. Yet, even as the boomers retire, they are being replaced with a less expensive and younger labor force. Second, an enormous number of part-time jobs have been created during the recovery. Many of these jobs are not as high paying as jobs in the past and don’t offer stability to employees. Yet, they are still factored into the broad unemployment rate.

It is hard to see inflation, as calculated by the Bureau of Labor and Statistics, moving over the Fed’s 2 percent target any time soon.

Another issue is benefit costs, which have risen dramatically in the last 10 years. It is now more cost-effective to hire part-time workers with no benefits, than full-time workers with benefits. This hiring model persists because it makes sense for controlling costs: It is less expensive to hire two part-time workers without benefits than one full-timer with benefits.

So, that’s the conundrum: Fair or unfair, these factors account for simultaneous low unemployment and low inflation.

And with these factors as a backdrop, it is hard to see inflation, as calculated by the Bureau of Labor and Statistics, moving over the Fed’s 2 percent target any time soon. However, we may see some blips from time to time, as states begin to mandate a higher minimum wage, but this will be short-lived and affect only a small portion of the employed U.S. population.

Inflation may come back to a more normalized rate. However, the path to high inflation seems to be tempered for now, as discouraged workers and structural employment issues make it difficult to realize that high inflation rate the Fed requires to pronounce our economy a healthy one.

This article was originally published in the February/March 2016 issue of Worth.

Investing and the Economy

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