How the Internet Economy Killed Inflation

By Sam McBride

Despite its best efforts, the Federal Reserve has been unable to push the economy to its targeted 2% annual inflation. For four years now inflation has stayed resolutely below that target even as the Fed deployed an unprecedented program of bond buying and low interest rates in an effort to push prices up.

While the analysts that predicted the Fed’s actions would lead to significant inflation probably overstated the power the central bank has on the economy, we think the most significant cause of low inflation has had nothing to do with monetary policy.

Figure 1: Trends In U.S. Inflation

(Click on image to enlarge)

NewConstructs_TrendsInUSinflation_PastCentury_2016-09-21.png (927×399)

Sources:   Bureau of Labor Statistics

Figure 1 shows that since the early 80’s, the end of the “Great Inflation,” increases in the Consumer Price Index (CPI) have been steadily getting smaller and smaller. Compared to the wild swings of the rest of the 20th century, this trend represents a dramatic change.

This new trend coincides with a couple of major technological innovations that have had a long-term impact on prices:

  • In the mid 1970’s, shortly before inflation peaked, Honeywell developed the first Distributed Control System (DCS) in the U.S., a tool that drastically increased the capability of factories to automate parts of the manufacturing process.
  • In 1994, when we see a flattening of the inflation trend-line, Netscape Navigator was released. Netscape was the first web browser that made the internet accessible to the broader public and presaged the internet takeover of so many facets of the economy.

These technologies and the subsequent innovations they inspired have combined to hold down inflation by putting pressure on wages, increasing productivity, and encouraging competition.

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