MNI INTERVIEW: Medical Costs to Slow US Inflation Next Year

U.S. core PCE inflation will slow to just under the central bank's 2% target next year, San Francisco Fed senior economist Adam Shapiro told MNI, as a number of coronavirus-related healthcare laws that have boosted medical prices unwinds along with today's surge in auto prices.

"If you add together the 0.5 percentage points from used cars and around 0.3 percentage points from healthcare services, that's a little under a full percentage point that's probably not going to be there next year, and if anything you might see a drag," Shapiro said in an interview.

Health services, one of the largest components of core PCE inflation with close to 20% of expenditures, contributed approximately 0.2pps on average to core PCE inflation in the five years preceding the pandemic, he said. Shapiro estimates the contribution from healthcare tripled to 0.6pp during the pandemic as the government set more prices, momentum that should fade or reverse in 2022.

"In 2023 we're projecting that will be around the target right around 2%," Shapiro said. Inflation pressures may build up a bit again in 2023 with unemployment "significantly lower," he said.

TAME LONG-TERM EXPECTATIONS

Health-care services in the PCE index are based on payments from insurers to physicians and hospitals and Medicare looms large because it's the single biggest payer, he said. Medicare price changes also tend to be followed in private healthcare rates. Changes to Medicare rules over the past year include a 20% add-on for coronavirus treatments, a temporary moratorium of the 2013 Medicare sequestration 2% payment cuts, and a temporary 3.75% increase in payments to physicians.

"These price increases are actually temporary, so they're only supposed to last for about a year or so," he said. "When they come off the exact opposite is going to happen and you're going to see a decrease in the price level of these services."

Shapiro's comments come after Dallas Fed President Robert Kaplan told MNI this week he was revising up his inflation forecast based on recent data, a Dallas Fed economist highlighted stronger gains in the trimmed mean PCE, and an Atlanta Fed policy adviser noted signs of more durable price pressures from housing and dining out costs.

While inflation expectations have moved up, long-term expectations don't look concerning, he said. That's in line with this week's New York Fed data showing a jump in year-ahead inflation expectations but steady three-year ahead expectations. Data released Friday from the University of Michigan also showed year-ahead inflation expectations jumping to 4.8%, while median five-year-ahead expectations were more steady at 2.9% in July.

"We would start worrying about upside inflation risk if we saw longer-term inflation expectations rise, and not only rise but they'd have to rise significantly and then once that happens you'd start to get some head turns," he said.