Modest gains in health-care prices have kept inflation levels low, according to a Federal Reserve Bank of San Francisco Economic Letter, released Monday.

“Dissecting the underlying price data by spending category reveals that low inflation largely reflects prices that are relatively insensitive to overall economic conditions,” San Francisco Fed Economic Research Department associate economist Tim Mahedy and research advisor Adam Shapiro, write in the research paper. “Notably, modest increases in health-care prices, which have been held down by mandated cuts to the growth of Medicare payments, have helped moderate overall inflation. Further slow growth in health-care prices is likely to remain a drag on inflation.”

The Federal Reserve Bank of San Francisco building.
The Federal Reserve Bank of San Francisco building.

In the eight years since the recession ended, inflation remained stubbornly below the Federal Reserve’s 2% target, with core personal consumption expenditures (PCE) prices up approximately 1.5%, on average.

While analysts have suggested numerous reasons for low inflation, “including low energy prices, a strong dollar, and a high degree of labor market slack,” all of which no longer apply, Mahedy and Shapiro write, Fed hair Janet Yellen recently called it a “mystery” why inflation hasn’t risen more.

“We show that the key driver holding down acyclical inflation, and hence core PCE inflation, over the past few years has been persistent changes to the health-care sector that began after the end of the recession,” they write. “Specifically, cuts to Medicare payment growth rates — which can affect prices throughout the health-care sector — have restrained health-care services inflation.”

Since health care is a major component of PCE, “price changes within this sector can have sizable effects on overall PCE inflation.” Mahedy and Shapiro estimate health-care has subtracted about 0.3 percentage point from core PCE inflation.

Although the authors expect inflation in the sector to increase in the future, they don’t see it reaching pre-recession levels, “which could restrain core PCE inflation for the foreseeable future.”

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Gary Siegel

Gary Siegel

Gary Siegel has been at The Bond Buyer since 1989, currently covering economic indicators and the Federal Reserve system.