The latest data, courtesy of the Census Bureau, which released its annual update on incomes and poverty yesterday, showed that median household income increased a whopping 5.2 percent in 2015 to an inflation-adjusted $56,516. As the New York Times, noted, it was “the largest single-year increase since record-keeping began in 1967.”

Some killjoys will note that median household income was $57,909 in 1999. That’s true, but the dot-com crash, housing bust and the credit crisis managed to cut that a lot. Median incomes fell 2.59 percent from 2000 to 2004, before almost rebounding to the pre-crisis peak. After 2007, the collapse was greater — a 4.94 percent drop that bottomed in 2013.

Positive Surprise

Ignore the naysayers; the most recent numbers were a huge positive surprise, showing that incomes for all Americans are rising in a meaningful way. Unlike in recent years, when much of the gains went to an increasingly narrow group at the top of the economic strata, last year’s improvements were broad.

Gains were spread across the income spectrum and by race, while women’s earnings inched closer to men’s.

This is yet more evidence of a job market that, as we previously noted, is not getting weaker but stronger — despite the occasional disappointing number.

Of particular surprise to many was that the strongest gains were found among the lowest earners. To what shall we attribute these gains? Two things deserve most of the credit:

More people working: The big year-over-year change in employment, with almost 2.5 million more Americans working now than a year earlier, contributed to a meaningful change in total household income.

Corporate pay increases: Some of the U.S.’s largest employers, such as McDonald’s and Wal-Mart, have played a significant role in raising incomes at the lower end of the income distribution. Wal-Mart in particular made substantial increases in wages for its lowest-paid employees. These increases stand in sharp contrast to the company’s pay policies of just a few years ago. Note that the increases are not just a public-relations effort, but due to the competitive labor environment; higher pay is needed to recruit and retain workers (and because workers demoralized by the low pay and unappealing employment conditions were hurting the shopping experience for Wal-Mart customers).

The latest data is unequivocally good for households; what investors need to do is consider what this might mean more broadly. Rising incomes have ramifications for inflation, Federal Reserve policy, interest rates, retail spending, auto sales and residential real estate.

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Post from Bloomberg

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But in the age of digital-account management, this cost is nonexistent. The same is true of so-called menu costs, a name for the hassle of companies changing their posted prices. In the modern world, these things just don’t matter that much. A more sophisticated argument against inflation is that when companies want to change their prices but for some reason can’t, inflation distorts prices from what they should be, which decreases economic efficiency.

Measuring these costs

Economists have tried to measure these costs, and found that they’re just as small as we might expect. In 1981, and again in 2000, University of Chicago economics professor Robert Lucas — sometimes cited as the father of modern macroeconomics — investigated the costs of inflation. Lucas’s chosen model told him that inflation doesn’t put much of a dent in human welfare — according to his 2000 paper, 10 percentage points of inflation is only about as harmful as a 1 percent reduction in gross domestic product. In other words, according to Lucas, even a mild recession is worse for people than the inflation of the 1970s.

Lucas’s model didn’t take into account the menu costs mentioned above. But economists Ariel Burnstein and Christian Hellwig looked at those in 2008, using data on how often companies change their prices.

They find that, as one might expect, inflation has almost no perceptible impact on productivity — and hence, on well-being.

So the typical arguments for why inflation is bad don’t stand up. A better argument is that when prices rise fast, they also tend to be more volatile — high inflation equals uncertain inflation. If inflation is predictable, lenders and borrowers can build it into their financing deals; nominal interest rates simply rise to take into account the shrinking value of money.

Workers can ask for cost-of-living increases in their paychecks, effectively indexing wages to inflation. And businesses can build inflation into their investment plans. But when inflation bounces around from month to month, it’s harder to plan for the future. That makes financing, investing, hiring and any decision that involves forward-looking planning much more of a gamble. Naturally, that will tend to hurt growth.

Historical correlation

Although the historical correlation between inflation and inflation uncertainty is well-documented, that doesn’t mean the one causes the other. If the Federal Reserve had a 4 percent inflation target, and managed to hit that target every year — thus eliminating uncertainty — we wouldn’t really be any worse off than if it hit its current 2 percent target.

So what does this imply about Fed policy? A lot, actually. The Fed’s so-called dual mandate, as laid out by Congress, is “to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” But that says nothing about the relative weights that the Fed should put on maximum employment versus stable prices. The central bank is perfectly free to worry about this.

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Post from Bloomberg

The post Overcoming Our Inordinate Fear of Inflation appeared first on Tripeak.