Deflation Is Coming Back

Durable Goods Are Becoming Cheaper

Following a notable surge in inflation, Americans are now witnessing a phenomenon absent for the past three years: deflation. It is for now predominantly observed in appliances, furniture, used cars, and other specific goods. However, widespread deflation, where prices of most goods and services consistently decrease, does not seem imminent.

Economists anticipate a further decline in prices for goods, potentially facilitating a return to the Federal Reserve's 2% inflation target, possibly as early as the second half of the upcoming year.
Durable goods, encompassing long-lasting items, have experienced a year-over-year decline for five consecutive months. According to data from the Commerce Department released on Thursday, these prices were 2.6% lower in October compared to their peak in September 2022.

This decline in durable goods prices has contributed to a reduction in core inflation, excluding volatile food and energy categories, to 3.5% in October, down from 5.5% in September 2022, as measured by the personal-consumption expenditures price index—the preferred inflation gauge of the Federal Reserve.

Services Are Still Increasing

However, the prices of services such as home rental and car insurance continue to rise, albeit at a decelerating pace. In October, they increased by 4.4% from the previous year, slower than the 4.7% growth seen in September but still surpassing pre-pandemic levels.

Economy-wide deflation is an uncommon occurrence and is typically indicative of stagnant or severely depressed demand. Conversely, deflation in specific sectors is more commonplace.
Before the pandemic, durable goods prices decreased by an average of 1.9% annually from 1995 to 2020 due to globalization shifting production to low-wage countries and productivity improvements lowering costs.
The pandemic temporarily reversed these trends, causing product shortages, disrupted supply chains, and a surge in consumer demand, leading to price spikes in 2021 and 2022. Durable goods inflation reached a 47-year high of 10.7% in February 2022.

Research by Adam Shapiro from the San Francisco Fed indicates that supply disruptions, such as closed factories or shipping delays, accounted for roughly half of the inflation surge in 2021 and 2022.

Supply Chain Issues Eased

For now, supply chains are functioning smoothly, according to a New York Fed index. At the same time, demand has been restrained by the Federal Reserve's interest rate increases, with consumer spending rising by 0.2% in October before adjusting for inflation, marking the weakest growth since May.

The White House Council of Economic Advisers suggests in a recent blog post that improved supply chains, coupled with weaker demand, account for approximately 80% of the decline in inflation since 2022.
Looking ahead, economists at Morgan Stanley predict that core goods deflation will intensify through the middle of the next year due to improved supply chains and weaker demand, counterbalancing ongoing price increases for services. Consequently, they foresee the PCE inflation dropping to 1.8% in September, below the Fed's target.

Prices, comprising the cost of inputs—labor, materials, capital—plus profit, surged as wages and certain inputs became pricier during the recent inflationary period. Limited supply and robust demand enabled companies to expand profit margins, implying that as these conditions subside, prices and margins will retreat.

Disclaimer

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