Core inflation

The Bureau of Labor Statistics reported yesterday that its primary consumer price index CPI-U rose 5.6% over the last year. That’s the highest inflation rate in 17 years, the newspapers all call to our attention. Just how concerned should we be about these numbers?

Of that 5.6% year-over-year price increase, 1.9% came within the last two months alone. And there’s no question that the big story driving that 2-month increase has been energy prices. NewJerseyGasPrices.com reports that the average retail price of gasoline sold in the United States rose from about $3.78/gallon in the middle of May to $4.12 in mid July, a 9% increase. That’s in line with the 10.6% 2-month increase that BLS reported in their seasonally adjusted consumer energy price index between May and July. Energy prices have a weight near 10% in the total CPI. That means that if energy prices had held constant between May and July but all other price increases had been the same, the year-over-year CPI number would have been more like 4-1/2% rather than 5-1/2%.

But does it make any sense to ask, What if energy prices hadn’t gone up between May and July? There are certainly good reasons why the Fed should not be taking as much comfort in “core inflation” as it has in recent years. But in this case, there is a clear need to net out the May-to-July energy price increase– it’s already been reversed. The US national average gas price is back to $3.78/gallon, right where it was in mid-May. Thus, even without any further drop in the price of gasoline– and personally, I do expect further drops– the 4-1/2% number is a better summary of where we stand right at the moment than 5-1/2%.

So no, I don’t think that yesterday’s CPI numbers will cause the Fed to panic. Because yesterday’s news is already way of out of date.



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29 thoughts on “Core inflation

  1. Justin

    Interesting analysis regarding core inflation and the volatility of energy.
    The main problems I see with it are that the Fed (and Bernanke in particular) claims to be concerned with “inflation expectations”, whatever those are. Clearly, volatility in energy prices affect these expectations, which are really just inflation incarnate. That energy moved up and then back down seems sort of moot in this regard. We all experienced the spike in gas prices, which in turn means we all experienced higher inflation. If anything, the magical “inflation expectations” are certainly worse today than they were prior to the volatility in energy prices we experienced in recent months.

  2. algernon

    What is there in the water that professional economists drink that is causing them to keep trying to explain inflation away? It isn’t enough that the CPI has been mucked up as a measure with all the hedonic/owener’s equivalent manipulation? Inflation x-inflation.
    The Fed & central banks around the globe continuously create fresh money/credit at a faster pace than their economies can create GDP on which to spend it. It’s called inflating. Why do economists strive to obscure this most important of truths?
    Burgeoning inflation in the teeth of recession is remarkable, but let’s just ignore it.

  3. wogie

    Wonder what effect the seasonal adjustment played in the 5-1/2 inflation jump. Earlier months the adjustment dampened the increase and was due to go the other way in June or July.

  4. sjp

    Algernon: How is JDH explaining inflation away? It’s a measurement issue being raised. Is your suspicion is that he wouldn’t bring up this point if it went the other way? Unless that is what he’d do, I don’t see how the intent here is to “explain away” anything.

    Consider this important truth: if the money supply was constant and GDP growth was zero, and everyone increased the prices of their goods, we’d have inflation.

    Justin makes a good point, JDH: the rise and fall of gasoline prices may not have symmetric effects on inflation expectations (you appreciate economic asymmetry, right?). Certainly there were myriad production and labor decisions made while gasoline prices were taking off — these might exert inflationary pressure going forward. And I don’t think the relapse in gas prices will do the same thing in the opposite direction.

  5. algernon

    ‘Consider this important truth: if the money supply was constant and GDP growth was zero, and everyone increased the prices of their goods, we’d have inflation.’ SJP are you serious?

  6. Anonymous

    sjp wrote:
    Consider this important truth: if the money supply was constant and GDP growth was zero, and everyone increased the prices of their goods, we’d have inflation.
    sjp,
    Don’t disengage your logic. If the money supply remains constant but everyone increased their prices how could we have inflation?
    Assuming spending preferences do not change we would have to sell less of everything. There would be no more money to purchase goods at the higher prices.
    At first retail inventories would increase and merchants would have to decrease orders. Manufacturing inventories would build and manufacturing would have to decrease. Depending on the severity of the decline unemployment might increase. Generally this would bring on a recession.
    You do raise an interesting scenario though because this is almost exactly what happened to precipitate the Great Depression right after the market crash in 1929. The crash only lasted 11 days, but Hoover over reacted and called the business leaders into his office as it was still going on to ask them not to lower wages and prices. The result was that inventories grew as production slowed and people lost their jobs. Hoover continued his foolishness of keeping wages and prices higher than the market would bear, attempting to offset the consequences with government welfare, but the economic decline drove unemployment higher than 20%.

  7. jg

    Sure, Professor, given the drops in the price of gasoline over the last weeks, yesterday’s price increase news is out of date.
    But, we are from from out of the woods. Just wait until the Japanese, Chinese, and sheikhs tire of seeing their Treasury holdings decrease in value. When they rush for the exits — next year seems plausible, as the U.S. economic fundamentals will be terrible through 2012, given the off-the-charts household debt to GDP ratio, and such prognosis will become widely apparent next year — and dump those Treasuries, we’ll see the pent-up effects of our inflationary policies since ’81.
    Enjoy the respite, and save what you can, now.

  8. baxter

    The real point is not about whether the correct inflation is 4 1/2% vs 5 1/2%.
    In April, when seasonal adjustments got the numbers disconnected from reality, all one could hear was inflation is low.
    When eventually, the data catches up, it’s explained away as old data.

    So there seems to be this great obfuscation by methodology – when methodology produces low inflation, the result is rationalized, and when methodology produces high inflation, the result does not matter.
    So there is never any inflation.

    That trick works, until it wont. Credibility will be lost, if not already.

  9. Anon

    This is almost as good as the ole: “it’s not really inflation because employees don’t have bargaining power.” I wonder if that originated with the Bank Of Zimbabwe.
    Why even bother reporting data? Simply have the BLS regularly declare deflation or low or no inflation – whichever suits them. You know, “heckuva job, Benny.”
    The power of orthodoxy, even in the 21st century is quite remarkable. Either that or a simple desire for access and/or social acceptance in professional circles.

  10. BLS Lackey

    The BLS publishes many special-purpose indices. The one Jim’s re-created here is “all-items, less energy” or SA0LE. No need to do the back-of-the-envelope re-weighting that you did here. We’ve done it for you.
    Go to http://data.bls.gov/cgi-bin/srgate and enter “CUUR0000SA0LE”.

  11. sjp

    algernon and Anonymous: I am seriously engaging my logic. Inflation is about the price level moving up.

    I am bringing this up because the true mechanics of inflation must be a combination of (among other things) the extension of money/credit that algernon refers to and the raising of prices that I posited. One can’t just point the finger at money supply expansion as the root of inflation. It is clearly an important part, but not the complete picture.

  12. Mike Laird

    There has never been an inflationary period when housing prices declined and gold prices declined. Both are down significantly. Additionally, money velocity is trending down (people are holding cash), and wages are not rising significantly. OK, oil has been up, but, so what?

    The word “whining” comes to mind. We are not in an inflationary period. And when its all analyzed with historical perspective, we will find yet more faults in the CPI reporting of our government. Economists of the future – here’s another opportunity.

  13. PrefBlog

    August 15, 2008

    James Hamilton of Econbrowser takes a brief look at the US Inflation numbers and concludes:
    there is a clear need to net out the May-to-July energy price increase– it’s already been reversed. The US national average gas price is back to $3….

  14. algernon

    To aver that we are not in an inflationary period strains credibility: The massaged-to-understate CPI of 5.6% was a year-over-year measurement.
    Wages not keeping pace does not change the fact of what the consumer has faced. One doubts that wages are much of a factor in the inflations of Zimbabwe or China.
    In addition to transportation & food costs, medical costs (which inspite of being 17% of GDP only count 6% in the CPI), property taxes, utilities, natural gas, parking fees, postal costs & gardening supplies are all up noticeably in my particular experience. Mr. Laird, do you not encounter these?
    Housing & gold are correcting from huge inflations in their prices (neither of which was captured in the CPI when they occured). Gold will likely move higher, if not in the near future, then later when the US gov’t must print its way out of the SS/Medicare promises it can’t keep.

  15. sonia

    We will see a great deal of shifting to Wal Mart, unbranded gasoline, and Corian (from granite) etc. Declining housing (sale) prices should bring rents down. We will see “getting the best deal” glamorized on the new reality TV shows replacing the most glamorous kitchen remodel. Assuming no really beligerent actions in the mid east or the Caucuses, oil prices should continue to decline (on a cyclical basis). So a reasonable bet is that inflation will be declining in the next year.

  16. algernon

    Those expecting diminishing inflation, please contemplate CD rates of 3%(on which the holder must pay income tax) when the reported CPI is 5.6%. What person would lend his savings in such a money-losing proposition? Is this the result of a free market or of a central bank lending out money that has never been saved but created out of thin air? MZM & M2 are growing a lot faster than GDP & have been for some time.
    The central banks of China, Russia, India, Saudi Arabia, et al are behaving similarly. The global credit bubble, Bernanke’s savings glut, will collapse in due course. But it seems to me we aren’t there yet & therefore are beset by inflation.

  17. OER

    …not only, but also… FED shouldn’t panic because:
    1. Rent inflation seems under control (It was slower in July than in June)
    2. Households & Investors inflation expectations are going down after the commodities prices burst (See: the yield of the Treasury Inflation Protected Securities & the latest results of the Consumer Sentiment Survey released by the University of Michigan: they are consistent with a moderation of the inflation scare).
    If past FED speeches are any guide, this excerpt from the 06/09/2008 Bernanke Speech (At the Federal Reserve Bank of Boston) will help shaping the prospects for the near term future:
    Here is the link to the website:
    http://www.federalreserve.gov/newsevents/speech/bernanke20080609a.htm

  18. DickF

    sjp wrote:
    Inflation is about the price level moving up.
    I am bringing this up because the true mechanics of inflation must be a combination of (among other things) the extension of money/credit that algernon refers to and the raising of prices that I posited. One can’t just point the finger at money supply expansion as the root of inflation. It is clearly an important part, but not the complete picture.
    sjp,
    I will pass on your incorrect definition of inflation as price increases to stay on topic.
    Can you give me the mechanism where prices can increase with a constant money supply without reducing consumption? If you have an economy of $5 and 5 things how can the price of the each thing move to $1.10 and consumers still consume 5 things with a $5 money supply?

  19. roger

    DickF – they’d put it on their visas!
    When economists talk about wage demands being muted, they don’t seem to understand how much American households have gotten into the habit of taking their future wages out as borrowed money. If I have the ability to pay 1.10 with a credit card, I can overlook that shortfall in my real income. By using behavioral patterns which were true in the 70s but are not true today to connect commodity prices to wages, economists are overlooking a central feature of the economy they have wrought. In fact, dissolving limits on credit has been the only way that the “grand moderation” could be swallowed by the American public at large. If they had to live within their real incomes, the increases in the compensation of the wealthiest group – the CEOS, the hedge funders – would simply be politically impossible. As credit is squeezed and Americans have to live within their real incomes, look for inequality to become a much hotter issue. It is the credit squeeze more than inflation that is going to jumpstart pressure to raise wages.

  20. Anonymous

    from the Fed Website: “Consumer credit rose at an annual rate of 5 percent in the second quarter. Both revolving and nonrevolving credit increased 5 percent in the quarter. In June, consumer credit rose 6-3/4 percent at an annual rate.”
    The pace of growth of Consumer Credit in June has been a surprise, a puzzle.
    So: where is the Credit Crunch?
    http://www.federalreserve.gov/releases/g19/Current/

  21. sjp

    DickF: my definition of inflation is a rise in the price level. The only point I’m making is to dispute algernon’s point; I took algernon’s point to be that inflation comes solely from money supply expansion. I say that’s not true.

    I believe that the problem subsequently raised with my thought experiment (0 growth, 0 money supply growth, price increases) is that it is non-equilibrium. What Anonymous suggested makes sense. On the other hand, the economy might realize that the price increases weren’t warranted and drop the price back down — this might be the outcome DickF sees for his scenario. I thought a non-equilibrium thought experiment might be worth considering, though, since the jumping off point for this post is that the oil price increases we saw in the summer have been followed by price decreases: we are talking about fluctuations about the equilibrium.

    I am most interested in Justin’s point, that these oil price fluctuations might inordinately affect consumers’ inflation expectations. It makes me wonder if certain high-profile products are weighted highly in consumers’ belief formation mechanisms. Have oil price shocks been associated with shocks to consumers’ inflation expectations, and is this association stronger than the association with other commodities?

  22. bill j

    DickF asks “Can you give me the mechanism where prices can increase with a constant money supply without reducing consumption?”
    Simple, the rate of circulation of money can increase or decrease. Thus even if the supply of money remains the same prices can change.
    And of course, there are many types of virtual money that can step into the gap, taking the place of money, debit accounts, credit accounts, loans of all descriptions etc.

  23. DickF

    Roger,
    Your comment about Visas did make me laugh, but understand that credit works within an economy unless the government facilitates credit expansion with an increase in the money supply so credit in itself does not create inflation.
    sjp,
    Inflation is a decline in the value of money. It may lead to a rise in the price level, but a rise in the price level is not inflation. This is a huge misconception in economic circles that leads to serious misunderstandings.
    If you introduce other elements into your thought experiment such as consumption preferences then yes you can create a scenario where such price increase might be accomodated, but the thought process must be deeper than a fixed money supply with rising prices. That simply is not possible without external input meaning consumption preferences, saving preferences, etc.
    This is important to understand because without the complicity of the monetary authorities an economy cannot experience inflation. Understand that a change in consumption preferences is not inflationary.
    bill j,
    A change in circulation of money does not exist in a vacuum. There must be other changes such as consumption preferences for this to happen. Dig deeper.

  24. Broxburnboy

    The definition of inflation I am familiar with is “too much money chasing too few goods”. I’m not sure that this definition holds up any more, as the current situation features rising core prices, with no apparent shortage of goods.
    The last time around (late 70s-early 80s) the problem was an out of control, self stoking, inflationary spiral where higher prices begot higher wages which begot higher prices etc..After wage and price controls proved ineffective, the solution was to curtail money supply and its velocity by aggressively raising interest rates. A hard landing ensued, but in relatively short order, the cycle began anew.
    This time around the driver of higher prices is not spiralling labour costs, but the decrease in purchasing power (devaluation) of the US buck through a flood of liquidity which originates from public deficit spending and the unprecedented rate of consumer spending funded by borrowing on perceived home equity (negative savings).
    Last time’s solution of raising interest rates would work too well this time and cause the hardest of hard landings. The supply of money (the dollar is really debt, an IOU from the American economy) is already being reduced by the implosion of the credit bubble and its velocity restrained by the reluctance and inability of banks to lend.
    The question that remains to be answered is: will this destruction of purchasing power (demand) result in
    a: a soft landing, manageable inflation, a few bankruptcies and a mild recession
    b: a medium landing with a protracted recession and perhaps deflation ala the Japanese experience
    c: a disastrous landing with a semi permanent recession, inflation, decreasing standard of living, and the collapse of the US dollar and it status as the world’s reserve curency.

  25. DickF

    Broxburnboy wrote:
    The definition of inflation I am familiar with is “too much money chasing too few goods”.
    Brox,
    This is a quickie pop definition of inflation but it does not really consider the demand component of de/inflation. I believe that much of our current inflation is because there has been reduced foreign demand for dollars.

  26. Nick

    Justin: The main problems I see with it are that the Fed (and Bernanke in particular) claims to be concerned with “inflation expectations”, whatever those are. Clearly, volatility in energy prices affect these expectations, which are really just inflation incarnate.

    You have the correlation right but the causation backwards: it is changes in inflation expectations that are now the dominant driver of most commodity prices, and especially of gold and oil.

    Fortunately, the Fed can now measure 10-year CPI-U expectations using TIPS prices, which is almost as good as looking at changes in gold prices and commodity indices to track changes in long-term inflation expectations. As a result I expect Fed policy to improve.

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