Health care costs aren't rising fast enough for the Fed's liking, and that may help keep interest rates lower for longer.  But is the problem one of persistent 'under-inflation' or simply the result of a bloated system falling in line with other countries' health care spending per capita?  If the Fed is really concerned that health care costs aren't rising fast enough, the unpleasant conclusion is that when those costs finally do rise, it might coincide with rising rates--eventually.   Rising costs and rising rates... just what an economic recovery needs, right?  Confused and angry?  Read on...

Bloomberg is reporting that the apparent success of the Patient Protection and Affordable Care Act (ACA) in bending the cost curve of health care may not be a complete blessing.  Despite the concern that has been expressed in recent years over skyrocketing medical and prescription costs, it appears that we need at least some of those costs increases.

Bloomberg said that the Federal Reserve is now worried about the nation's low rate of inflation and "part of the problem is the sluggish rate of increase in health care costs."  Newly installed Federal Reserve Board Chair Janet Yellen and her fellow members are looking at those costs as part of their interest rate considerations and thinking perhaps they should keep rates at current near-record low levels.

Price increases excluding food and energy rose only 1.1 percent on an annual basis in February, down from 2 percent in the preceding 12 months and Bloomberg said medical goods and health-care services accounted for about one-third of that decrease.  The cost of health-care services rose only 0.8 percent on an annual basis in February where those costs had averaged 2.6 percent over the previous 10 years.  The cost of medical goods and drugs dropped 50 basis points from the 10 year average of 2.7 percent.

It isn't just the ACA that is effecting costs, although information from other sources such as Motley Fool credit new regulations for cutting hospital readmissions and thus reimbursements for seniors under Medicare.  Medicare reimbursements were also cut under sequestration and there were a surge of cheaper new generic drugs arriving on the market last year as patents expired on several popular brand name medications.  In 2012 drug manufacturers lost $24 billion in sales (almost 10 times the 2011 total) as new generics became available and are expected to lose about $14 million this year.  The generic drugs also carry lower co-pays for consumers, usually about $10 compared to $50 per script.

Bloomberg said its analysts looked at government personal consumption exemption (PCE) data and found February's 1.1 percent core PCE reading matched January's as the lowest since March 2011.   The Fed's preferred measure, PCE inflation which does include food and energy costs, was even weaker, a 0.9 percent year-over-year pace, less than half the Fed's 2 percent inflation goal.

Yellen has stated that policy makers fear a lack of inflation could pose risks to economic performance.  For example low interest rates hurt savers and insurance lines with long term claim payment obligations such as long-term care insurance.  There are also indications that investors are nervous about the prospects for inflation and have pulled millions out of some popular exchange-traded funds that track its progress.  Economists also see low inflation rates making it more difficult for individuals and businesses to pay off debts and for businesses to boost profits.

Health-care costs, which are about a quarter of the core PCE, are expected to grow slowly this year with 63 percent of the economists Bloomberg surveyed expecting a slower than historic increase and 8 percent predicting health-care costs will fall.  Already the rate for physicians' fees fell from a 1.6 percent increase in February 2012 to 0.2 percent 24 months later while nursing home costs in the same period dropped to an increase of 0.3 percent from 1.8 percent.  Bloomberg said economists have yet to see the ACA lead to any health care cost increases. Medicare officials, in fact, said recently that they now believe that hospitalization cost trends that were previously said to be dropping have done so more than originally reported.              

The problem appears to be that as Medicare costs and reimbursements diminish, private insurance companies will follow the government's lead and there will be lower reimbursement rates for hospitals, physicians, and all kinds of health-care related goods and services.       

The downward pressure on health costs may ease a bit this year Bloomberg says, as fewer drug patents are expiring.  It won't be enough however for the Fed to reach its 2 percent inflation goal.   Yellen, in a mid-March press conference told reporters, "If inflation is persistently running below our 2 percent objective, that is a very good reason to hold the funds rate at its present range for longer," although she did not specify a time frame.