August 31, 2020
U.S. inflation has slowed sharply since the onset of the coronavirus pandemic and a new Federal Reserve study squarely pins the blame on a collapse in demand as consumers sheltered in home to avoid infection.
The Fed targets 2% inflation according to the personal consumption expenditure (PCE) price index. It also pays close attention to a core reading of that gauge which strips out volatile food and energy prices. Both measures have plummeted since the pandemic, with year-on-year core PCEs standing at 0.9% in June versus 1.9% in February.
“Current data shows that the recent drop in core PCE inflation is mainly attributable to large declines in consumer demand for goods and services stemming from COVID-19,” said Adam Hale Shapiro, a research adviser at the Federal Reserve Bank of San Francisco. That has “more than offset any upward inflation pressures due to supply constraints in some sectors,” he wrote in an Economic Letter published on the bank’s website Monday.
Shapiro sorted the dozens of different categories of goods and services captured by core PCE into two buckets: COVID-19-sensitive and COVID-19-insensitive, depending on whether the price or quantity of a specific category changed meaningfully as the virus took hold.
He found that service categories were especially prone to suffering a big change in quantity and price compared with goods categories, particularly air travel and hotels which saw steep declines in both measures.
“In February 2020, COVID-19-sensitive categories contributed 1 percentage point and COVID-insensitive inflation contributed 0.9 percentage point to total year-over-year core PCE inflation,” Shapiro wrote. According to his calculations, the contribution of COVID-19-sensitive categories fell to 0.4% and 0.6% for COVID-19-insensitive. “COVID-sensitive inflation is therefore responsible for about two-thirds of the 0.9 percentage point decline in year-over-year inflation between February and June,” he said.
While I am not surprised by these findings, they highlight the importance of getting our economy back on track. I read what Shapiro posted and want to add:
“Months after the onset of COVID-19 in the U.S., core PCE inflation remains at particularly low levels—approximately a full percentage point below the Federal Reserve’s 2% target. Breaking down the components of inflation as proposed in this Economic Letter can help monitor the impact of the pandemic on inflation. Consistent with the findings of Leduc and Liu (2020), current data show that the recent drop in core PCE inflation is mainly attributable to large declines in consumer demand for goods and services stemming from COVID-19, which have more than offset any upward inflation pressures due to supply constraints in some sectors,” explained Shapiro.
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Stay safe,
Marty McCarthy, CPA, CCIFP
Managing Partner
McCarthy & Company
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