Inflation rates remain low, dragged down by prices not sensitive to the economy, but that should change in 2018, according to Federal Reserve Bank of San Francisco President John Williams.

“With the economy doing so well this year and based on the historical pattern, I expect to see a rise in inflation in 2018,” Williams told an audience in Phoenix, according to prepared text released by the Fed.

Federal Reserve Bank of San Francisco President John Williams
Federal Reserve Bank of San Francisco President John Williams Bloomberg News

He cited a “lengthy” expansion, record stock levels and soaring confidence as signs of the health of the economy.

The one question everyone asks is why inflation has failed to rise. Williams said Fed researchers determined “prices that tend to move up and down with the economy have recovered. But inflation for things that tend to be less sensitive to the economy have fallen or remained low.” Specifically, prices of pharmaceuticals, airline tickets, cell phones and education have held down inflation.

Also, “mandated cuts to Medicare payment growth have muted price rises in overall health-care services,” he noted, adding, there is usually a 12-month delay for a strong labor market to impact prices.

Although low inflation levels would generally mean the Fed would keep interest rates low, it has chosen to address falling unemployment levels and move to normalize monetary policy.

Williams said he has been asked why rates must rise “when monetary stimulus had such a positive effect” and wouldn’t keeping rates low help the economy.

“But the reality is that, if we don’t move interest rates back up to more normal levels, we risk undermining the sustainability of the expansion and creating conditions that could lead to a recession down the road,” he said. “As long as the data continue to show steady growth and we see the uptick in inflation that we’re expecting, my own view is that we should continue to raise interest rates slowly over the coming year.”

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