US inflation has been lower than standard economic models would predict throughout the current expansion.
Some blame the rise of Amazon for keeping prices low, but there is another so-called "Amazon effect" that might be more relevant for central bankers.
That’s according to a paper presented on Saturday by Harvard Business School economist Alberto Cavallo at the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole, Wyoming.
Mr Cavallo's main finding was that competition from Amazon has led to a greater frequency of price changes at more traditional retailers such as Walmart, and also to more uniformity in pricing of the same items across different locations. He found that the shift has led to a greater influence of movements in the US dollar exchange rate and gas prices on retail prices.
“For monetary policy and those interested in inflation dynamics, the implication is that retail prices are becoming less ‘insulated’ from these common nationwide shocks,” Mr Cavallo wrote. “Fuel prices, exchange-rate fluctuations, or any other force affecting costs that may enter the pricing algorithms used by these firms are more likely to have a faster and larger impact on retail prices that in the past.”
That dynamic may complicate matters for Fed officials as they navigate the signals from unemployment and inflation while setting interest rates. A paper published on Thursday by top staff economists at the Fed’s board of governors in Washington cautioned against focusing too much on inflation and not enough on unemployment.
Part of the rationale is that in an environment like the present, where the relationship between unemployment and inflation seems to be weaker than it has been historically, external shocks to prices unrelated to domestic demand conditions could lead policy makers astray. Fed chairman Jerome Powell cited the Fed staff paper on Friday in a speech at the Jackson Hole conference without offering a full-throated endorsement of its conclusions.
The Cavallo study also showed that from 2008 to 2017, as online purchases accounted for an ever-growing share of total retail sales, the average duration of prices of goods sold at large US retailers like Walmart fell from about 6.5 months to about 3.7 months.
The implications have subtle significance for monetary policy because so-called “sticky prices” - the notion that sellers aren’t able to change prices right away in response to changes in supply and demand - is precisely what gives interest rates power in mainstream models to have any effect on the economy at all. In those models, if prices adjust instantaneously in response to shocks, then there is no role for central bankers to guide supply and demand back into equilibrium.
“For monetary models and empirical work, my results suggest that the focus needs to move beyond traditional nominal rigidities,” Mr Cavallo wrote. “Labour costs, limited information, and even ’decision costs’ [related to inattention and the limited capacity to process data] will tend to disappear as more retailers use algorithms to make pricing decisions.”