The tech boom is boosting US inflation

Tech retail prices in the US have swung from falling over recent decades to posting large gains, with the turnaround under way well before AI started to take off.  Tech has switched from consistently subtracting ¼pp from annual core inflation to adding ¼pp. This boost is likely overstated because of measurement problems with software, but there has been upward pressure on inflation from every type of tech good and service.  The Fed might argue for keeping rates steady because the tech boom should ultimately be deflationary, but the Fed still has a problem with high non-tech inflation, which is also tracking well above the Fed’s 2% target.

Core inflation in the US – as measured by the core PCE deflator – has picked up from a low early last year of 2.6% to 3.4%, which is well above the Fed’s 2% target.

Some of this pick-up reflects the lagged impact of tariffs on goods prices, although this effect should soon fade in the monthly figures.

The tech boom, which has been turbocharged by immense investment in AI, should ultimately be a deflationary influence on the US economy depending on how AI boosts productivity.

In the short term, though, the boom has directly contributed to higher inflation, with tech switching from being a longstanding constraint on inflation to adding to price pressures.

Calculating the direct impact of tech on core inflation, tech can be approximated by grouping a range of goods and services, including software, streaming, internet access, computers, tablets, phones, and AV equipment.

On this basis, tech accounts for about 6% of all consumer spending, excluding food and energy, with the share relatively stable except for a spike during the pandemic.

In aggregate, estimated tech prices are up almost 5% over the past year, which compares with average annual declines of about 3½% during the 2000s and 2010s.

While the AI boom has accelerated the recent surge in tech prices, prices were turning around during the pandemic, well before the public release of ChatGPT in late 2022.  

The large turnaround in prices has caused tech to switch from subtracting an average of 0.2pp from annual core inflation over the 2000s and 2010s to adding 0.3pp.

More recently, this means that tech prices have accounted for about one-third – or 0.3pp – of the 0.8pp increase in core inflation from last year’s low of 2.6% to 3.4%.

More broadly, it also means that if tech prices were falling like they did in past decades, core inflation would be around 2.9% instead of 3.4%.

  

However, it is worth noting that the increase in tech prices – and hence their contribution to core inflation – is likely overstated. This is mainly because the Bureau of Labor Statistics, which supplies the underlying data to the Bureau of Economic Analysis, has difficulty adjusting for quality improvements when calculating hedonic estimates of price changes.

Another issue relates to accidentally capturing huge AI-driven price gains for flash drives and related media that are not included in consumer spending.

The Fed has analysed these measurement problems for the price of software and accessories, which, on our calculation, has increased by 15% over the past year, accounting for 0.2pp of tech’s estimated 0.3pp contribution to core inflation.

The Fed concluded that, “a quarter to well over a half of the contribution of the computer software and accessories category to core PCE inflation may be imputed to measurement error.”

If this is correct, then tech might have only added 0.1-0.2pp to core inflation over the past year, such that “true” core inflation might round to 3.3% instead of the published rate of 3.4%.

Even so, the Fed’s focus on software, while understandable, overlooks the fact that there has been strong upward pressure on all tech prices. This is clear from comparing the current change in prices for each series with growth prevailing prior to the pandemic. 

While the pressure on tech prices should abate when the current boom inevitably peaks – after all, investors seem unlikely to achieve an adequate return on the massive investment in AI – it should be noted that there is still upward pressure on non-tech inflation.

On our calculation, estimated non-tech core inflation has picked up from a low of 2.8% last year to 3.3%. This should ease when the impact of tariffs on goods prices finally fades over the rest of this year, but it still seems that, regardless of the exact direct contribution to inflation from the tech sector, the Fed faces a difficult job in sustainably returning inflation to the 2% target.