By Fernando Martin, Senior Economist
For the past three decades, consumer prices in the U.S. have grown at an average pace of 2 percent per year. Despite several recessions, various stock market crashes and a severe financial crisis, prices have shown none of the volatility that characterized the 1970s and the early 1980s. The figure below shows the average consumer price level, as measured by the personal consumption expenditures price index, normalized at 100 for January 1990.
Since January 2012, the Federal Open Market Committee (FOMC) has explicitly interpreted its price stability mandate as meaning 2 percent annual inflation, thus matching stated policy with previous performance. However, inflation has fallen well short of this target since then. The dotted line in the figure above shows the path the price level would have followed since January 2012 had it grown at 2 percent annually. As we can see, prices have been diverging away from target, growing at only 1.1 percent annually. Even after “liftoff” in December 2015, inflation seems to be underperforming.
Digging under the surface reveals that not all prices move in tandem. In fact, there are significant differences in trend and volatility. To see this, I divided consumer expenditures into the three major components:
The figure below shows the price level for each of these categories, again normalized at 100 for January 1990.
The price of nondurable goods (e.g., food and gas), which account for roughly one quarter of consumer expenditures, has been growing at about 1.7 percent annually, a slightly slower pace than the average price level. Interestingly, there was a marked slowdown after the last recession. In fact, prices for nondurables have remained roughly constant since mid-2011.
Much of the behavior of prices for nondurable goods, especially fluctuations in the short term, are determined by energy prices. The steady decline in oil prices since 2014 explains the recent drop in the nondurables price index.
In contrast, the price of durable goods has been steadily declining since the mid-1990s, averaging a contraction of 1.3 percent annually over the sample period. This trend, largely driven by the ongoing decline in the price of consumer electronics, does not show any signs of reversing or slowing down. Note, however, that expenditures in durable goods represent only about 10 percent of consumer expenditures.
Finally, the average price of services has been growing at a faster rate than the overall price level. Over the sample period, the price of services grew at 2.7 percent annually, although this rate decreased markedly after the last recession to about 2.1 percent annually.
Services currently account for roughly two-thirds of all consumption expenditures, and this proportion has been increasing steadily over time. Housing and health care are two categories that are widely responsible for the fast rise in the cost of services.
As the relative weight of expenditures continues to shift away from goods and into services, the trends described above suggest a light upward pressure on inflation in the future. However, this shift in weights alone would not be enough to raise inflation back to its 2 percent target.