By: Richard A. Anderson
Talk of inflation has heated up in the last few weeks, with fears that higher than expected inflation could cause the Federal Reserve to raise interest rates at a faster pace. This was one of the contributing factors to the recent volatility in the stock market and has driven U.S. Treasury yields higher.
Inflation is one of the economic data points monitored by the Federal Reserve, which targets a 2% long run inflation rate. When the signs point to inflation exceeding the 2% target, the Fed will take action by raising interest rates to cool the economy. Since the Great Recession of 2009, the Fed has been taking measures to increase inflation by maintaining historically low interest rates to stimulate consumer spending.
Inflation can be defined as a general increase in the overall price level of goods and services in the economy. Overall inflation, as measured by the consumer price index (CPI), has been benign over the past twenty years and has been relatively low since the start of the economic recovery in 2009. While overall inflation has been low, inflation has existed within certain areas of the market.
The chart below from the American Enterprise Institute’s ‘Carpe Diem’ blog shows price changes for selected U.S. consumer goods and services and wages as compared to the entire basket of goods and services that comprise CPI from January 1997 through December 2017.
The goods and services in red are those that have had prices increase at a faster rate than overall inflation, while those in blue have had price increases slower than overall inflation. There are a few points that stand out right away when looking at this chart.
1. Healthcare (hospital services and medical care services), college expenses (college textbooks and college tuition), and childcare are notable outliers in terms of goods and services that have increased faster than CPI.
2. Technology (TVs, software and cellphone service) are notable outliers in terms of goods and services that have become significantly less expensive over the last 21 years.
3. Wages, as measured by the increase in average hourly earnings, have increased by 81.5%, which is not significantly greater than overall inflation.
The key takeaway from this chart is that although overall inflation has been low over the past two decades, there have been certain segments of the market where inflation has been rampant and certain segments where costs have declined significantly. This means that certain groups of the population have been affected by inflation differently because very few Americans consume the average market basket of goods and services measured by the CPI.
In general, two areas that make up the majority share of the average household’s spending are housing and medical expenses. Retirees, whose Social Security benefits are subject to a cost of living adjustment (COLA) tied to CPI, have been most adversely affected by the meteoric increases in healthcare costs. Young professionals and those just starting a family have benefitted from costs for housing, food and beverage and new cars increasing at a lower rate than overall inflation. They have also benefitted from lower technology costs.
At HIGHLAND, we monitor overall inflation as well as price changes of certain goods and services like healthcare, college and cost of living. By monitoring and analyzing the different inflation rates, we can be more precise when building your financial plan. Our financial planning software, MoneyGuidePro, allows us to break out specific financial goals (i.e. health care costs and college expenses) and assign those goals different inflation rates. The chart above highlights why this important because different costs rise at different rates.
Currently, HIGHLAND’s assumptions for inflation for planning purposes are as follows:
If you have any questions about inflation or how we incorporate inflation expectations into your financial plan, please reach out to a member of the HIGHLAND team.