Inflation’s back?

Does today’s CPI release indicate that inflation has returned?


The Bureau of Labor Statistics today released the consumer price index for September, which showed a 4.7% increase relative to September 2004. That’s the fastest 12-month rise since 1991 and suggests you’d need to spend almost 5% more dollars now to buy the same things you purchased a year ago.

The big number is entirely accounted for by energy prices. The fuels component of housing, which has a weight of 4.0% in the BLS index, went up 15%, and gasoline, which has a weight of 3.9%, went up 55%. Thus, even if the price of every item other than fuels had been unchanged, the CPI would still have risen by 2.7% over the last year:

(0.040) x (15) + (0.039) x (55) = 2.7

Should you care that the inflation is virtually all energy prices? Not if you’re Barry Ritholtz, who correctly observes that this means costs for consumers and firms have gone up, and sees no merit to leaving out the items whose costs have risen the most.

But as Dave Altig cogently argues, if you’re the Federal Reserve, you should care a great deal. Alan Greenspan does not have the ability to pump gasoline for free into your car. The Fed can do nothing about the increase in the relative price of fuel. So, if you said that the Fed should keep overall inflation below 2.7%, in order to meet this objective they would have to put so much pressure on the economy that the price of everything other than fuel actually declined. That would undoubtedly mean further drops in real income, which would make it harder, not easier, for you to buy gas and heat your home.

What if you’re an investor thinking about buying a bond? What matters to you in that case would be how much the CPI changes between now and the time you get your return in dollars. If your goal is to predict where the CPI is headed, again the empirical evidence suggests you would want to look at what’s happening to core inflation rather than outliers such as energy.

And of course, for all three– households, the Fed, and bond-holders– a key question is what the energy shock means for real economic activity. On that score, William Polley notes some other disturbing economic news today– the University of Michigan’s index of consumer sentiment has continued to fall, declining from the 76.9 value that had already been a big concern to 75.4 in September.

Pick your poison, inflation or recession. Personally I’m more scared of the second.

35 thoughts on “Inflation’s back?

  1. Barry Ritholtz

    Its not just oil and natural gas — its food, aluminum, copper (all industrial metals), cement, timber, precious metals, copper (I really like copper), health care, education — pretty much across the boards.

    See this CRB chart for more details.

    Its apparent that most commodities have been in a robust uptrend since 2001 — so no, its not just energy.

    As opposed to the near half century long chart, please allow me to suggest using a 4 year graph. That will provide you with much better insight into recent inflationary data. The very long perspective is good for a 40,000 foot view, but it obscures more recent data —

    Unless you are really curious as to what inflation was like the first time the Beatles appeared on Ed Sullivan!

  2. Rich Berger

    Does the BLS index capture the effect of a shift in expenditures? With a fixed income, if a consumer must pay more for fuel, he or she must reduce consumption of other goods. I don’t see why an increase in the cost of one or two items should be considered inflation. I thought inflation was a rise in the general price level, such as we saw in the 1970’s and early 1980’s. I don’t find Barry’s argument that increases are occurring across the board, otherwise inflation excluding food and energy would be going up.
    On the other hand, I have always thought that the price of gold was a fairly reliable indicator of inflation. Given that the dollar seems to be holding its own against the euro and yen, are those countries also experiencing inflation?
    Just wondering.

  3. Anonymous

    Barry’s right, it’s not just energy.
    But I don’t think the CRB index is the only way to look at input prices. That’s mostly raw materials, which are very volatile. Other measures show pipeline pressures are easing.
    For instance, the core PPI intermediate (which includes all sorts of manufactured goods, like chemicals, metals, etc.) peaked at 8.6% year-over-year in January; it’s now down to 3.2%. This index has peaked at the height of every inflation scare we’ve had for the past 30 years, which the CRB hasn’t. This core PPI intermediate index has done a very good job of predicting Fed moves over the Greenspan era. It also seems to weakly predict future CPI.
    Barry: I know you hate BLS, but open your mind.

  4. JDH

    If fuels were only up 2% over the last 12 months, then the CPI would only be up 2% over the last 12 months rather than the 4.7% recorded. That’s the sense in which I say that today’s news is all energy prices.

  5. randy

    I would agree with Jim, except the Fed has to worry about credibility. The Fed can certainly control inflation (and must signal its intent to do so, or run into the 70s again), but its ability to control the economy is much less certain (long and variable lags, blah blah blah). We still don’t have a solid answer to the question, “what causes recessions?”
    Which CPI? The “ordinary” CPI doesn’t allow substitution across major categories of goods over, say, 2-3 year horizons (weights get changed gradually over time), but does allow substitution within categories of goods. The “superlative” CPI allows more substitution, but is not as timely. (PCE also allows more substitution.)
    CPI minus food and energy is not necessarily the best low-frequency signal of CPI; see Bryan and Cecchetti.
    In any case, just because a consumer shifts away from fuels, doesn’t mean he/she is equally well off. The purchasing power of $1 has fallen. (But substitution lessens the pain.)
    Without a look at the evidence, I find it hard to believe that the price of gold would be a reliable signal of inflation. It’s relative price has to fluctuate with relative supply and demand. Moreover, you get all these “buy gold NOW” adds which are attempting to start a bubble.

  6. spencer

    We are seing a coupe of things. First, a big jump in relative prices as energy prices rise.
    Everything else being equal this should cause the demand for everything else to decline.
    But of course, every thing else is not equal.
    So the question is will this increase in energy prices feed through to the rest of the economy and cause generalized inflation. My compliments to Barry, but industrial raw materials are such a small share of the overall cost of production
    that the same thinking applies there.
    The key question is whether the rise in energy and industrial raw materials is absorbed in corporate porofits, or do they pass it through to other prices and we get generalized inflation.
    So far the answer is no — there is essentially no evidence of widespread increases in other prices because of rising material and energy costs.
    The Fed agrees, but is extremely fearful that it will happen next year — that is what happened in the 1970s. But in the 1970s rising oil and industrial raw material prices largely reflected generalized inflation already flowing through the system.
    But now, retailers are unable to pass higher costs through, and along with auto firms are having to slash prices to sustain sales.
    So the risk are very high that the Fed tightening to prevent inflation may actually end up causing deflation as the economy plunges.
    For the last few years the fed has been rightly proud of the great job it has done to eliminate inflationary expectations. But now when we get the first real test of this policy the fed appears to be chickening out.

  7. RayJ

    “The 4.1 percent cost of living adjustment (for 2006) announced today by the Social Security Administration is the biggest increase since a 5.4 percent gain in 1991. Last year’s increase was 2.7 percent.”,1,3402004.story?track=rss
    Given the relatively low inflation rates reported until today’s 4.7%, to what should one attribute the jump in COLA? Is this an indication that inflation is expected to be greater than 4% over the next year or two?

  8. focus

    Is it really inflation?

    Suppose you had a case where every component of the CPI stayed flat except for one input–energy.

    Let’s say the demand for energy goes way up. The supply can not adjust upward right away so the price goes up a lot because of the increased demand.

    The CPI measurement would show a huge increase, but is that really inflation–in the the sense that the currency is being debased?

    It seems to me that the change in CPI does not really measure inflation in this case, it is really responding to the supply shortfall that is driving the price up.

    The real result is that output will be limited by the available input. Our standard of living will suffer because we can’t produce as much.

    In other words, this is not a monetary effect at all so it is not really inflation. It is the lack of a key input. The only solution is a greater supply of the input.

  9. Robert Sczech

    I agree with Prof Hamilton that inflation is more desirable than recession. Recession means unemployment for more people while inflation means only the loss of purchasing power of money.
    In my opinion (I am not an economist), the issue of inflation is intimately related to the issue of economic growth. Everybody wants economic growth yet the question whether growth is truly desirable is never discussed seriously. In my opinion, inflation is the price to pay for unsustainable growth policies. We need growth in order to mask and silence the problem of a very uneven distribution of wealth in our society. The answer to the problem of poverty is always more growth. Since poverty is always relative to what constitutes wealth (the poor in the US are quite rich in comparison to the poor in India), more growth usually does not eliminate poverty but increases only the gap between the poor and the rich. One reason is inflation which always hits the bottom of society harder than the top.
    I agree that the cost of energy and food should be eliminated from the CPI. Oil price increases due to oil depletion or food price volatility due to draught/bad weather should not have an effect on monetary policy. However, the hefty increses in taxes, government fees, college tuition and health care fees should enter the CPI fully. These are costs which can not be avoided as there is no competition from China in medical services or educational services. There is a certain unfairness that workers in manufacturing are exposed to the competition from Chinese workers while college professors and medical doctors (among many other professions) enjoy a monopoly situation with regard to competition from abroad. The low CPI figure is partly due to the unfair emphasis on products mostly made abroad while the escalating cost of services in the US does not fully enter the CPI.

  10. Movie Guy

    I agree with the points that you and Dave Altig have raised. And I understand what Barry Ritholtz is saying. I agree with him also which puts me in an odd position.
    As mentioned on Brad Setser’s blog, I expect that we may see a potential wave of brief inflation hit households and local businesses as the strains facing the hands-on service industry and retail industry come to a head. As illogical as this may sound, I expect that lower volume sales and service calls will cause companies in those industries to pass on larger shares of their transportation costs to consumers. I am saying that those companies have thus far generally held the line of marking up their prices. But they can’t continue to do that and maintain profits as volumes collapse. I think that many are running very thin margins right now.
    The counter argument is that they can’t pull this off if their competitors hold the line on passing along such costs. True. But few may do that. Something may have to give, and most may jump on the bandwagon. If volume sales collapse, then they have to attempt to make it up. Can they? We’ll see. If not, some companies will be in big trouble.
    So, I believe that there is some hidden inflation down at the community levels that we haven’t factored in thus far. But it is probably inbound. What may drive the transporation pass along issue? Perhaps 100% increases in minimum monthly credit card payments, as well as the obvious decline in the ‘other than work’ highway traffic volumes in many parts of the country. The traffic counts are way down in some areas. Almost spooky, including some interstate traffic.
    I would also suggest that a major recession is all but guaranteed at this point. The credit card minimum bump was a badly timed move. One that the Fed will regret engineering.

  11. Jack Miller

    No! A recession is not necessarily in the cards and inflation is not so bad. One difference in the 70’s is that the Fed did not “get over the top”; real interest rates, although high, were negative for most of the decade. At about this point in the cycle in the 90’s, the Fed jumped a half percent that even in hind sight many say was too much; however, the market was convinced, gold rolled over, unemployment went up a little and inflation fears subsided. The next sereral years were pretty good years of growth with moderate inflation. This cycle has the same potential as the 90’s. As was mentioned, the PPI has already rolled, energy supply is on the increase and demand has softened. Another small bump or two will not put us into recession but will encourage the world to conserve energy. My bias is clear, I am a Greenspan fan. I believe he is close to threading the needle. Some of the hottest economies (such as Australia) have finally slowed down (China has acutally reduced its oil consumption in 12 months) and Japan and Germany have turned away from the risk of deflation. Energy prices will probably reduce the broad CPI for the next several years as oil prices are likely to be below $45 per barrel within that time.

  12. PaulS

    I remember with no great fondness how the government used inflation to rob my grandmother of her life savings in the 1970s in order to subsidize obscenely overpaid folks in the auto industry, so I’m not prepared to easily agree that inflation is “not so bad”. Times have changed and the rule that kept real interest rates on her savings highly negative is gone, but it remains that inflation is fine and dandy mainly for highly affluent folks who have easy access to sort of large-denomination financial instruments that best keep up with it.

  13. cm

    focus: The (CPI) definition of inflation is an increase in prices of the basket of goods and services that the CPI monitors. The original intent, which is still somewhat intact, was to track the “cost of living” of workers. To that end, the CPI is based on a value judgement (what does cost of living mean, and why is it important), and is not an entirely “objective” indicator. Thus the CPI measures price inflation, not currency inflation, but they are not independent variables.
    Nevertheless, a rising CPI means rising cost of living. If one believes one can live without food and energy, then everything is nice and dandy.

  14. pgl

    Nice post. My only addition (over at Angrybear) is that the BLS index of real wages has them down by 3% since the beginning of 2004.

  15. Barry Ritholtz

    Since my initial comment (first in this thread), I’ve been rethinking your use of a 45 year chart. Given that it serves only to obscure the most recent inflationary data, I must ask you to explain why you chose this timeline.

    Without a proper defense of this silly half century long chart, the only conclusion one is left with is that this was a purposefully dishonest tactic. It is a completely pointless chart — unless your goal is to make the very real inflation appear benign.

    Since only political hacks would engage in such willfully deceptive and dishonest behavior (and I do not believe that describes the author of this blog), I must ask again for some articulation as to the purpose of this misleading graphic.

    Lucy, you got some ‘splainin to do.

  16. kuros

    i called my ac/heating tech to get my regular check up of my system for the winter and i mentioned last years 29.00 service call charge; i was told it was raised to 39.00 because of the rise in fuel cost for their fleet of trucks
    i think you get the idea

  17. dryfly

    Pick your poison, inflation or recession. Personally I’m more scared of the second.
    I don’t see why we can’t have BOTH… some raw material price inflation simultaneous with domestic output decline due to foreign labor rate arbitrage. In effect ‘stagflation’ with more ‘stag’ than ‘flation’.

  18. PEmbertron

    How do we know the high price of commodities, including oil, is not caused by excessive Fed easing? Jeffery Frankel argues that ultra low real interest rates are a significant factor in explaining the run-up in oil prices in recent years. See his FT article of April 15. So putting energy prices outside the monetary policy induced inflation core may be erroneous. Arguments that elements of inflation were outside Fed control appeared in the Burns era with disastrous consequences.

  19. JDH

    Gee, Barry, you should visit more often. I very often use 50-year charts when data are available– take a stroll through some of my other posts.
    In this case, I think one of the questions on people’s minds is whether we’re headed for a replay of the 1970’s. So putting the 1970’s together with the current data seems informative.

  20. bubba

    I completely agree with cm’s post on this subject, and have always questioned why these two items (food and energy) recently have been kept track of separately. As they are kind of the base ingredients for human existance, and they are imbedded into every other product, what is the rationale for keeping track of the Consumer Price Index without them? I don’t know about your households, but the main purchases at my household every week are food first then energy. On a monthly basis, the combination of my electricity and natural gas bills seem to hit us increasingly hard also.

  21. Maynard

    Obviously whether we get more “stag” or more “flation” depends on what the Fed does. I’m worried about recent apoplectic statements regarding inflation from the Fed. They seem poised for a pretty aggressive ratcheting up of interest rates, which seems to me an overreaction. I get the feeling that the Fed still has the mindset of one whose credibility is hanging by a thread: if they don’t get aggressive against inflation, then the oil price increases will quickly work their way into wages and prices, and we’ll be back in 1978. I think the Fed should take advantage of its rock-solid credibility: let the oil price increases work themselves out, expecting (hoping?) that wage and price setters are not going to suddenly come to the opinion that the Fed is no longer serious about controlling inflation. Let the economy continue generating the jobs that are needed to reduce slack in the labor market. If you’re not going to take advantage of your credibility at a time like this, why sacrifice so much to establish it in the first place?

  22. Barry Ritholtz

    That’s fair enough — problem is, the very long term charts distort the shorter term price phenomena. So much so that on a 10 year chart of the Nasdaq, you cannot even see the effects of 9/11.
    The 4 year chart obscures the Fed’s mad rate cutting post-bubble/recession/9.11, and it hides the pace of rising prices.
    In fact,

  23. TCO

    This post and many of the comments are irking me. I lack having had any classwork in econ (macro or micro). My main education in the art is from reading Free To Choose at age 12. But fundamental concepts of supply and demand, time value of money, options, CAPM, etc. are pretty intuitive, no? And in general the macro stuff that I read seems to be poorly expressed in terms of real mechanisms and tends to have logic jumps and hand waving. I wish I had the real training in these subjects. But instead will try to think my way through it here and throw the bullshit flag rather fearlessly. If you can prove me wrong; great, I’ve learned. If you can’t prove me wrong, great, I’ve slain some fluffy thinking. On to the sequential reactions:
    I agree reflexively with idea of not leaving goods out of the CPI. I mean they were there before, why take them out when they go up? If we were going to do that, we ought to have a “core” that just excludes any products with rapid rises (regardless of type). The same in reverse for droppers? What’s the point?
    From basic Milton F. point of view of inflation as too many $ chasing too few goods, the reduction of oil supplies should NATURALLY lead to inflation (as a first order reaction). Same $, immediate reduction of goods -> higher $/goods ratio (inflation). It will also mean that the standard of living for the society has been immediately reduced. Same population, less goods -> immediate drop in goods/person consumed. So yeah, it’s inflation and it’s a shittier life. But the interesting thing is that it does not mean continued inflation or continued reduction in real consumption (since we’ve posited a step change and the shock is over.
    I don’t understand/agree with the comments about “the Fed has got a problem” by JDH. Your comment does not address subtleties like significance of metrics and action/reaction issues but instead seems to pedantically say that it is “bad” if a lot of prices go down to counteract a few going up a lot. WHY?? If the currency itself IS NOT being deflated (staying at 2.7), who cares? The danger of deflation has to do with capital markets and investment, no? Not with sticker shock. Or does it cost grocers more to mark down than up?
    Of course a key issue is what is really happening with the currency itself. I assume that the Fed’s job is to avoid real deflation. And avoid runaway inflation (which would seem to have more to do with government profligacy in spending, historically, than with conscious monetary policy). I mean Milton has told us that 10% a year (if you could keep it exactly like that) would be fine. NO PROBLEM. No need for wheelbarrows. No radical barter economy resulting, not even that bad in terms of physical costs of marking stuff up. Ideally the job of the Fed should be to keep inflation volatility down and keep currency from deflating. Of course a key issue here becomes (and one of the later posters addresses it) if CPI corresponds to real currency devaluation. This is another, seperate issue. But imaging the ideal case where CPI is really real inflation, who cares if we have a bunch of stuff going down? And the posited, not explained horror, that will occurr from some prices going down has that characteristic macro, hand-wave, and jump over a gap in the tracks-of-logic scent that offends my nose.
    (Reading Barry Titzy’s post at his site):
    Not sure what his main point is here other than to whinge a lot and act afraid of conspiracies. Is it that he is smarter than the market? Gawd save us, another market timer. Is it that he doesn’t think the metrics themselves are accurate? If so, that’s fine…but he ought to go after them in general with a long run argument…not an “I don’t like this month’s numbers and will whinge about it and cherry pick criticisms of the components, based on his gut (no other data, surveys, metrics…just how his cavity bill was). And so what that the CURRENT prices of houses is high. When we look at this month’s numbers, what we care about is how they have changed from their already exalted status, not that they are high (of course, he may have a valid kvetch about previous months when the housing WAS rising). And he doesn’t seem to realize that his point about mortgages dropping off is a sign that the demand for housing (and hence price rises) may have ebbed. Blows me away that he doesn’t think through clear implications of suplly and demand of a point he makes.
    That said, I do agree with his base point that life may be becoming harder and that Wall Street cheers should not be relied upon (nor should we take stuff out of the index…analogous to looking at true company cash flow, per Copeland, not pro forma reports or accounting metrics of profitability.) Of course, his post is also sadly lacking any discussion of, thinking about the real inflation rate as determined by the capital markets as shown by interest rates. His one point about “margins being squeezed” is interesting, but I wish he would clearly think it through in terms of a free competition model and an industry cost curve that for short periods of time is based on variable costs (but for long periods of time on total cost). So the issue is not “inability to pass on costs”, it’s just the untenable nature of long run production at this cost…since economic rentmust be earned. In effect it’s a temperary wealth transfer from producters to consumers and has the effect of keeping more goods in the economy, thus making the dollars/goods ratio a bit smaller than otherwise.
    Lot better article than Hamilton or Barry. Identifies the clear, one-time shock nature of a price increase from goods destruction and correctly says that reducing the inflation (with a monetary move) would not reduce the pain. Of course, Jim ought to realize the converse as well. That it shouldn’t ideally hurt either. They key thing is that wealth has been destroyed when Katrina hits the oil rigs. So we’re poorer. Discussion of how Fed can overcompensate, etc. would be only interesting thing to discuss. Not the Jim or Barry simple, wrong stuff. While I agree that the Fed should not overcontrol, I’m not clear that macroblog really supports his end conclusion. If the Fed could effectively control shocks, what would be wrong with that. (there may be some reasons here, especially wrt to a valve that affects money whereas goods can take an immediate value destruction shock…or the dangers of “hunting”, but while macroblog moves the argument to the right area, he doesn’t actually have the discussion needed within that area. Of course this post also fails to discuss bond rates.
    Back to JDH post:
    your last two paras are great thank God. You even included the damn bondholders that I was asking about a month ago. I’m still intrigued by idea of measuring “true inflation” by this means or using it as a check on CPI, hedonics, etc.
    Comments: Too tired to comment on all the silly ones. A few good ones, but covered already (except for the point about shifting of goods in the basket, not with hedonics, but with substitution/doing without…that one is very good point, and I’m not sure how to think about it).

  24. Accidental Verbosity

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  25. TCO

    An interesting thought experiment is some exogenous shock that increases the supply of goods (and thus is deflationary). If it is truly a one time shock, no need to increase money supply to stave off deflation (no harm either from doing so, if you really can be this adroit). What if it’s a shock that is not one time, but something that will continuously increase goods (productivity, “new economy”?) or decrease them (spiralling political problems?).
    If the Fed wants constant inflation (and for sure, no deflation) then they should change the setting on the money supply faucet in this case. What about implied future gains/losses (from stocks, etc.)? Is it the Fed’s job to evaluate the stock price? Or should they just take that as a market decision?

  26. TCO

    Hmm…just thinking out loud here. If the Fed does not adjust for one time exogenous (inflationary/deflationary shocks), then we could imagine that a bond holder/payer would take it in the A.., if the payout was after the shock. In theory, if the shock is never going to happen again, then that just sucks for the individuals, but they made their bet. Would not affect future capital expectations. However, if there is a chance of shocks recurring (and Fed as policy does not adjust for them), then capital demands will need to incorporate some expectation of inflation from shockiness. Also, would be a volatility component (CAPM), not just a higher inflation expectation. I’m not sure how significant this is or if the dangers of overcontrolling are worth the benefits of the Fed reducing this variability.
    What do y’all think?

  27. pat

    In your simple scenario, it is real inflation. Because if there is no inflation, then an increase of demand for oil means more money will be spent on oil, thus demand for other stuff will be lower, which should lead to lower prices for other stuff. Therefore, the fact that prices for other stuff do not drop means there is a general increase of prices (inflation), not just the relative price increase of oil.

  28. JDH

    TCO, although I didn’t mention Milton Friedman in particular, the idea that inflation results from too many dollars chasing too few goods is precisely what I talked about in my post on Stagflation. The bottom line is that, if an oil shock reduces output by 2%, other things being equal, that would increase inflation by 2%.
    The claim that a general deflation has potential for some real economic hardship is a conclusion that I draw on the basis of a number of historical examples such as the U.S. in the early 1930’s and Japan more recently. I do not believe that the Fed could succeed in getting prices of all non-energy items to fall without a significant increase in unemployment.

  29. TCO

    You’re going to have to do better than that macro-prof. Why should dropping prices (of several goods) cause wide-spread problems WHEN THE CURRENCY itself (as viewed by a bond holder) IS NOT dropping. Surely, reason for deflation being a danger is the lack of an incentive for investors to invest currency any more, since they make better returns by just holding cash. Or do you ascribe to some macro-weenie belief that people are irrational? Or does it have to do with the physical labor of changing the marked prices?

  30. TCO

    I mean the bottom line is that it is not a “general deflation” if a bunch of prices go down but the weighted average remains “not going down”. Look, I think you (maybe it was someone else) pointed out that a worker who gets more in his pocket because of inflation is not getting anything really more valuable. Because the dollars are worth less in buying power. There’s no difference with giving me 100 dollars that has been inflated 10% or giving me 90 (or 91, not sure the math) dollars that has not been inflated at all. Who cares if the prices go up down or stay the same. The only problem is the output reduction itself.
    I would agree that AN ACTUAL deflation might cause some problems because of capital markets no longer investing. But a “bunch of prices went down a little and one went up a lot and the weighted average remained slight inflation”? Who cares! that’s not deflation. It’s inflation with a change in respective value of oil and other goods.

  31. The Big Picture

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