Labour markets have been tightening sharply in the United States and Canada. The unemployment rate in the U.S. is well below 5 per cent, while in Canada the rate is quickly approaching 6 per cent. Generally, this development leads to rising inflation, as employers offer higher wages to attract new workers. Yet inflation in both countries remains below the 2 per cent target established by the central banks in both countries. Core and overall inflation have been below 2 per cent since March in Canada and since May in the United States.
Some economists contend that temporary factors, including the slump in gasoline prices a few months ago, are responsible for the absence of inflation. They predict that over the next few months, inflation will pick up and better reflect the ongoing tightness in labour markets. However, others assert that there has been a fundamental structural shift in the economy, which has important implications for monetary policy going forward. The thinking is that technologies such as e-commerce, Airbnb, Uber, robotics, horizontal drilling for shale oil, and artificial intelligence have kept a lid on inflation. Firms dealing with competitive pressures from some of these technologies have been reluctant to increase prices in this environment. In economic jargon, the Phillips Curve is flattening, implying that it is difficult to generate inflation even at low unemployment rates.
Much of the attention has focused on the effect of e-retailers on inflation. This segment of the retail market has expanded at an annual compound rate of 9 per cent over the last 15 years and currently comprises over 8 per cent of total U.S. retail sales. E-retailers cut costs by getting rid of middlemen and also provide a tool for comparing prices on a large number of goods. Shoppers can use their smartphones to check the price of products online while shopping in a brick-and-mortar store. Retail studies show that shoppers decide to purchase online even if the price differential isn’t large.
The influence of e-retailers, which has impacted the ability of brick-and-mortar retailers to pass cost increases on to their customers, has been at least partially blamed for the decision by Sears to close 300 of its outlets and the recent move by Toys “R” Us to seek bankruptcy protection. The problems that e-retailers have created for the book industry are well known.
The Bank Credit Analyst notes that the view that e-commerce has had a major impact on inflation is far from unanimous. Some point out that the main drivers of low inflation since the end of the 2008–09 recession have been lower prices for food, energy, and rent—sectors outside of the realm of e-commerce. Rent costs have recently come down sharply as millennials have finally started to purchase their first homes, a development that has resulted in weaker demand for rental properties. Also, e-commerce isn’t the first major revolution in the retail sector: In the 1990s, the proliferation of “big box” stores put downward pressure on prices as well. Analysts point out that e-retailers’ market share remains below that of “big box” stores. Consequently, the disinflationary impact of e-commerce may be overstated.
Finally, economists question why the development of e-commerce and other technologies hasn’t shown up in the productivity numbers. Positive supply shocks to the economy that contain costs should have led to an increase in productivity. But productivity growth has been declining since the 1990s, and that decline has accelerated since the end of the 2008–09 recession. It may take more time before these innovative technologies show up in productivity estimates, as was the case for the computer revolution.
It is difficult to accurately measure the impact of e-commerce on consumer prices, which explains the disagreements over its probable effect. In fact, apart from horizontal drilling for shale oil, which has had a major influence on lowering world oil and gasoline prices, the effects on inflation of other technologies like robotics and artificial intelligence are, if anything, even more challenging to estimate than the influence of e-commerce.
Despite these difficulties, there is little doubt that the U.S. Federal Reserve (Fed) is closely monitoring the potential moderating effect of modern technologies on inflation. Most Fed officials, including Fed Chair Janet Yellen, believe that weak inflation this year is due to transitory factors that will gradually wane as the year unfolds. However, a few members contend that there could be some merit to the view that limitations on pricing power linked to e-commerce and other technologies are restraining inflation below the 2 per cent mark. They are urging a cautious approach to future interest rate increases.
Our latest forecast update calls for a rebalancing of monetary policy as the output gap gradually closes. We expect interest rates in the U.S. and Canada to gradually increase over the near term. However, we feel that the Fed and the Bank of Canada must take a measured approach to future interest rate increases, given the lack of inflation in both economies. Inflation may not be dead or even on life support, but it will be important to closely monitor trends in inflation over the near term to verify the degree to which modern technologies are impacting the ability of firms to increase prices in response to rising demand.
Source: BCA Research, “Did Amazon Kill the Phillips Curve?” The Bank Credit Analyst, September 7, 2017.
Canadian Outlook with the Chief Economist: A Slowdown in Store
The Conference Board of Canada, December 18, 2017 at 02:00 PM EST
Live Webinar by Craig Alexander