When 2017 began, many economists expected inflation to accelerate. The labor market was tightening, and unemployment was low. But core inflation, which excludes volatile food and energy prices, registered just 1.9% year-over-year that April, down from 2.3% that January. Prices actually fell in March 2017, the first time U.S. consumer prices had dropped month-over-month since January 2010.
The situation then was unusual, but now, two years later, it’s increasingly clear that inflation remains tame—significantly below the 2% annual target set by the makers of monetary policy in many developed nations.
Why is this happening, when the U.S. job market remains tight? And what does it mean for investors? To answer the first question, look no further than Moore’s Law, which explains how ever-cheaper and ever-better technology reverberates through the economy. Vanguard explained Moore’s Law in 2017 and its lessons still apply.
Inflation has been falling short of the Fed’s target
Notes: Core inflation is measured by the Core Personal Consumption Expenditures Price Index (which excludes food and energy). Data cover January 1998 through March 2019.
Sources: Vanguard calculations, based on data from the U.S. Bureau of Economic Analysis, the U.S. Federal Reserve, and Thomson Reuters Datastream.
A closer look at Moore’s Law
Moore’s Law states that as technology improves, its relative price declines. The wholesale price of cell phones, for example, fell 13% in the United States in April 2017 from a year earlier. But Moore’s Law (coined by Intel co-founder Gordon Moore) is about more than tech products. Its indirect effects restrain prices in every corner of the economy.
According to the U.S. Bureau of Economic Analysis, the amount of technology used in producing goods and services more than doubled from 1997 to 2017, from 8 cents per $1 of output to 17 cents. The impact has been most pronounced in tech-intensive industries such as information technology and communications, professional services, and manufacturing. But as the figure below shows, even sectors that may seem less directly tied to technology—such as health care, education, and retail trade—have seen significant cost savings.
Our research suggests that declining input prices for computers and electronic products, computer design and services, and other technology inputs trimmed almost 0.5 percentage point per year from production costs from 2001 through 2017 and ultimately from wholesale prices. Without Moore’s Law, annualized U.S. inflation would have been almost 0.5 percentage point higher. Without technology’s price-suppressing effects, core inflation would be at 2% or more, achieving the Federal Reserve’s inflation target. The higher inflation that would have resulted would have forced the Fed to further raise interest rates.
Technology’s effects on prices, by industry
Notes: Data cover January 2001 through December 2017. A basis point (bps) is one-hundredth of a percentage point.
Sources: Vanguard calculations, based on U.S. Bureau of Economic Analysis input-output tables and Thomson Reuters Datastream.
Disclosure: Vanguard Investments
The information contained in this document does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction. This document is issued by Vanguard Investments Hong Kong Limited (CE No. : AYT820) which is licensed with the Securities and Futures Commission (“SFC”). The contents of this document have not been reviewed by SFC. Investment involves risk. Past performance is not indicative of future results. Copyright, trademark and other forms of proprietary rights protect the contents of this document. You may not copy, publish and/or distribute any derivative works from the information from this document.
© 2020 Vanguard Investments Hong Kong Limited. All rights reserved.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from Vanguard Investments and is being posted with permission from Vanguard Investments. The views expressed in this material are solely those of the author and/or Vanguard Investments and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.