Webster’s Dictionary defines inflation as “an increase in the amount of money in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices.” Inflation, as measured by the Consumer Price Index (CPI), has been low by historical standards for the last two decades, fluctuating between 0.5% and 3% on an annual basis.
While the construction of the CPI has often been criticized, other measures of inflation, such as the Producer Price Index, confirm that inflationary pressures have also been subdued. This benign inflation picture has been partially responsible for the ultra-low-interest rate environment we have experienced. At the same time, wage growth has been declining from five percent annual wage gains in 1997 down to less than two percent as recently as 2010. However, a combination of accelerating economic growth and declining unemployment rate (currently 4.7%) has caused wage gains, as measured by the Atlanta Federal Reserve Bank, to double in the last two years.
Higher wages put more money in the pockets of workers, increasing the amount of money in circulation. While we have a long way to go before we get back to the double-digit wage gains we saw in the 1970s and 1980s, we are seeing the initial hints that inflation is picking up. Other inflation indicators, such as commodity prices and various indices of costs of manufacturing supplies from the Institute of Supply Management, are increasing as well. In our April 2016 View from A Mile Up we identified some “green shoots of inflation” and the previous year we discussed the pent-up need for wage inflation. Prospects for higher inflation may nudge the Federal Reserve to pick up the pace of interest rate increases in the coming year.