Thursday, 15 of November of 2018

Economics. Explained.  

Category » Inflation

Producer Price Index

November 9, 2018

The Producer Price Index for final demand – intermediate demand  includes producer prices for goods, as well as prices for construction, services, government purchases, and exports and covers over 75% of domestic production.

Producer prices for final demand rose 0.6% in October after having risen 0.2% in September and having declined 0.1% in August.  During the past year this inflation measure (the red line) has risen 2.8%.  The PPI has been moving steadily higher for some time but its rate of ascent appears to have slowed.

Excluding food and energy producer final demand prices climbed by 0.5% in October after having risen 0.2% in September and having declined 0.1% in August.  They have risen 2.5% since October of last year (the pink line).  This series has been steadily accelerating for the past two years.  Inflationary pressures are gradually re-surfacing.

This overall index can be split apart between goods prices and prices for services.

The PPI for final demand of goods  jumped 0.6% in October after having declined 0.1% in September. These prices have now risen 3.6% in the past year (left scale).  But the October jump was entirely related to the volatile food and energy categories.  Excluding the volatile food and energy categories the PPI for goods was unchanged in October after having risen 0.2% in September.  During the past year the core PPI for goods (the light green line) has risen 2.4% (right scale).

Food prices jumped 1.0% in October after having fallen 0.6% in both August and September.  Food prices are always volatile.  They can fall sharply for a few months, but then reverse direction quickly.  Over the past year food prices have declined 0.8%.

Energy prices jumped 2.7% in October after having declined 0.8% in September.  Energy prices have risen 12.6% in the past year.  But given what has been happening to oil prices lately and their slide below $60 per barrel, it is clear that energy prices will fall sharply in November.  This recent drop is in large part because U.S. oil output is now surging and OPEC has increased its crude oil output.

The PPI for final demand of services jumped 0.7% in October after having risen 0.3% in September after having declined 0.1% in both July and August.  This series has risen 2.5% over the course of the past year (left scale).   The jump in service goods prices in both September and October were caused by a run-up in the trade services category.  These swings largely reflect the change in margins received by wholesalers and retailers (apparel, jewelry, and footwear in particular). .  The PPI for final demand of services excluding trade and transportation (the light blue line) increased 0.2% in October after having risen 0.3% in June, July and August, and September.  It has climbed 2.6% during the past year.  This series, like the overall index, has been gradually accelerating for some time.

The recent increases in producer prices were foreshadowed by the results of the Institute for Supply Management’s series on prices paid by manufacturing firms.  In the case of manufacturing firms the chart looks like the one below.  Price pressure were steadily building for six consecutive months.  Specifically, the price component rose steadily from 64.8 in November of last year to 79.5 in May.  The fact that every month was above 50.0 meant that prices producers were paying increased every single month.  Given that the level of the index steadily rose during that period of time indicates that price pressures were intensifying every single month.  However, from June through October this series has actually declined to 71.6  This means that prices continued to climb in those months, but the rate of increase was less than in other recent months.  Hopefully, this means that the steady upward pressure on the PPI is beginning to abate.

Because the PPI measures the cost of materials for manufacturers, it is frequently believed to be a leading indicator of what might happen to consumer prices at a somewhat later date.   However, that connection is very loose.

It is important to remember that labor costs represent about two-thirds of the price of a product while materials account for the remaining one-third.  So, a far more important variable in determining what happens to the CPI is labor costs.  With the unemployment rate currently at 3.7% the labor market is beyond full employment.  As a result, wages pressures have begun to climb, but much of the upward pressure on inflation should be countered by an increase in productivity.  Nevertheless, the tighter labor market should exert at least moderate upward pressure on the inflation rate.

Some upward pressure on labor costs, rents, and the cost of materials will put upward pressure on inflation.  We expect the core CPI to increase 2.2% in 2018 and 2.4% in 2019 after having risen 1.8% in 2017.

Stephen Slifer


Charleston, SC

Gasoline Prices

November 7, 2018

Gasoline prices at the retail level fell $0.06 in the week ending November 5 to $2.75 per gallon.  In South Carolina gasoline prices tend to about $0.25 below the national average or about $2.50. The Department of Energy expects national gasoline prices to average $2.75 this year.  

Spot prices for gasoline have fallen sharply in the past couple of weeks primarily because of the decline in crude prices.  If gasoline prices remain at their current level, pump prices will continue to slide.

The selloff in the stock market in October pushed oil prices back down to $67 per barrel with an expectation that higher short- and long-term interest rates will slow the pace of economic activity and, hence, push oil prices lower.  And now, in the past two weeks,  oil production around the globe has surged and reduced prices further to $62 per barrel.

For example,  U.S. production has surged to 11,600 thousand barrels per day.  Saudi Arabia has also increased its production.

Keep in mind that the Department of Energy expects production to average 10.9 million barrels this year but climb further to 12.1 million barrels in 2019.  This means that the U.S. became the world’s largest oil producer in March of this year and is expected to boost production by almost 10% in 2019 to further widen the gap between U.S. production, Russia, and Saudi Arabia.

There is so much oil currently flooding the market that oil inventories are rising rapidly.    However, at 1,086 million barrels crude inventories are still lower the 5-year average of 1,116 million barrels so one can hardly characterize this as an oil glut.  It is, however, a sign that currently supply is exceeding demand by a fairly significant amount.

The wild cards right now are production levels for Venezuela and Iran.  Venezuela’s oil output has been falling steadily for the past couple of years and is showing no sign of recovering.  Iran is different.  The Iran sanctions are going into effect right now.  Iranian production has not fallen too sharply yet, but the U.S. goal is to reduce exports (and, hence, production) close to zero.  Thus, as we go forward Iranian output could fall sharply and counter much of the recent oversupply.  OPEC claims it has ample reserves to offset any Iranian shortfall, but that surplus equipment is old and has not been used in some time so we will see.

Stephen Slifer


Charleston, SC*

Employment Cost Index

October 31, 2018

The employment cost index for civilian workers climbed at a 3.0% pace in the third quarter after having risen at a 2.4% pace in the second quarter.  Over the course of the past year it has risen 2.8%.  Thus, the labor market continues to get tighter, and to attract the workers that they want firms are having to work employees longer hours, and offer higher wages and/or more attractive benefits packages.

With the unemployment rate at 3.7% and full employment also presumably at 4.5%, it is not surprising that we are beginning to see a hint of upward pressure on compensation.

Wages climbed at a 3.6% rate in the third quarter after having climbed 2.1% in the first quarter.  Over the course of the past year wages have been rising  at a 2.9% pace.  Wage pressures are beginning to accelerate gradually.

Benefits climbed at a 1.8% annual rate in the third quarter after having risen 3.5% in the first quarter.   As a result, the yearly increase in benefits is now 2.6%.

What happens to labor costs is important, but what we really want to know is how those labor costs compare to the gains in productivity.  If I pay you 3.0% more money but you are 3.0% more productive, I really don’t care.  In that case, “unit labor costs”  — labor costs adjusted for the change in productivity — were unchanged.

Currently, unit labor costs  have risen 1.9% in the past year as compensation rose 3.2% while productivity increased by 1.3%.    As we look forward into 2019 we expect compensation to climb to about the 3.7% mark, but at the same time we expect productivity to rise by 1.9%.  Thus, unit labor costs at the end of 2019 to be rising at a 1.8% rate which means that there will be little if any upward pressure on the inflation rate in 2019 stemming from the tight labor market.  A 1.8% increase in ULC’s is clearly compatible with the Fed’s 2.0% inflation target.

Stephen Slifer


Charleston, SC

Gross Domestic Purchases Deflator

October 26, 2018

There are many different deflators that are available.  This one is for gross domestic purchases which measures prices paid by U.S. residents.  It is the one measure of inflation that the Commerce Department talks about when it releases the GDP report.   It is our broadest measure of inflation and contains more than 5,000 goods and services.

The gross domestic purchases deflator rose 1.7% in the third quarter after having rise 2.3% in the second quarter. Over the past year this index has risen 2.4%.

Excluding the volatile food and energy components this index rose 1.7% in the third after after having risen 2.5% in the second quarter.

Remember that these deflators are weighted measures of inflation.  That means that when a builder switches from using copper pipe to PVC to save money, it registers as a price decline in these particular inflation measures.  Or when a consumer switches from buying butter to less expensive margarine the result is the same.  Thus, the deflator represents a combination of price changes and changes in consumer and business behavior.

The CPI, however, is a fixed basket of goods and services.  So what it shows are price changes only which, to us, is what inflation is all about.   We believe that the inflation rate is headed higher.  With the unemployment rate at 3.7% the economy is at full employment which should boost wages and, at last, that seems to be happening.  Both manufacturers and non-manufacturing firms are reporting sharply higher prices for their raw materials so commodity prices are also on the rise.  A very short supply of available rental properties is boosting rents.  Hence we expect  the core CPI to climb from 1.8% last year to 2.3% in 2018 and 2.4% next year.  The one thing that is keeping the inflation rate in check is technology.  People are able to search the internet and find the lowest price available from Amazon or some other on-line website.  Thus, sellers of goods have absolutely no pricing power.  Prices of goods have fallen 0.3% in the past year while prices for services have risen 3.0%.

Stephen Slifer


Charleston, SC

Consumer Price Index

October 11, 2018

The CPI rose 0.1% in September after having risen 0.2% in both July and August.  During the past year the CPI has risen 2.3%.

Food prices rose 0.1% in July, August, and September.  Food prices have risen 1.4% in the past twelve months.

Energy prices fell 0.5% in September after having jumped 1.9% in August.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have risen 4.8%.

The recent run-up in energy prices seems to reflect two factors.  First,  oil production in Venezuela has dropped to a multi-decade low level given the chaotic political environment in that country.  Second, the supply situation in Iran is now highly  uncertain given the imposition of sanctions against that country that will take effect on November 4.  As a result, the International Energy Administration projects that demand will exceed supply by about 0.5 million barrels per day between now and yearend.   That is likely to put further  upward pressure on oil prices between now and yearend.

Excluding food and energy the CPI rose  0.1% in both August and September.  Over the past year this so-called core rate of inflation has risen 2.2%.  We expect the core CPI will rise 2.2% in 2018 and 2.4% in 2019.

The most interesting development in the CPI in recent years has been the dichotomy between the prices of goods (excluding the volatile food and energy components) and services.  For example, in the past year prices for goods have fallen 0.3% while prices for services have risen 2.8%.

With respect to goods prices, it appears that the internet has played a big role in reducing the prices of many goods.  Shoppers can instantly check the price of any particular item across a wide array of online and brick and mortar stores.  If merchants do not match the lowest price available, they risk losing the sale.  Thus, they are constantly competing with the lowest price available on the internet.  Looking at specific items in the CPI we find that prices have been unchanged for almost every major category in the past year.  New cars have risen 0.5%, televisions have declined 18.6%, audio equipment has dropped 14.3%,  toys have fallen 10.0%, information technology commodities (personal computers, software, and telephones) have declined 3.1%.  Prices for all of these items are widely available on the internet and can be used as bargaining chips with a traditional brick and mortar retailers.

In sharp contrast prices of most services have risen.  Specifically, prices of services have risen 3.0% in the past year.  The increase in this  broad category has been led by shelter costs which have climbed 3.3%.  This undoubtedly reflects the shortages of both rental properties and homeowner occupied housing. Indeed, the vacancy rate for rental property is at a 30-year low. This steady rise in the cost of shelter  will continue for some time to come and, unlike monthly blips in food or energy, it is unlikely to reverse itself any time soon.

The CPI, both overall and the core rate, will have an upward bias  in the months ahead because of what has been happening to shelter prices, gradually rising labor costs, and rising producer prices.  But on the flip side, the internet is keeping a lid on the prices of goods.  We look for an increase in the corer CPI of 2.2% in 2018 and 2.4% in 2019.

The Fed’s preferred measure of inflation is not the CPI, but rather the personal consumption expenditures deflator, specifically the PCE deflator excluding the volatile food and energy components which is currently expanding at a 2.0% rate but is  likely to head somewhat higher.  We expect it to climb 2.2% in 2019.  The Fed has a 2.0% inflation target.  However, going forward we have to watch out for the steady increases in shelter which, as noted above, is being pushed higher by the shortage of both rental properties and homeowner-occupied housing.   Shelter is a long-lasting problem and given its 33% weighting in the CPI it will introduce an upward bias to inflation for some time to come.  Also,  higher wages triggered by the shortages of available workers in the labor market could also put upward pressure on the inflation rate.

Why the difference between the CPI and the personal consumption expenditures deflator?  The CPI is a pure measure of inflation.  It measures changes in prices of a fixed basket of goods and services each month.

The personal consumption expenditures deflator is a weighted measure of inflation.  If consumers feel less wealthy in some month and decide to purchase inexpensive margarine instead of pricy butter, a weighted measure of inflation will give more weight to the lower priced good and, all other things being unchanged, will actually register a decline in that month.  Thus, what the deflator measures is a combination of both changes in prices and changes in consumer behavior.

As we see it, inflation is a measure of price change (the CPI).  It is not a mixture of price changes and changes in consumer behavior (the PCE deflator).  The core PCE should increase 2.0% in 2018 and 2.2% in 2019.  That compares to the Fed’s targeted rate of 2.0%.

Keep in mind that real short-term interest rates are negative.  With the funds rate today at 2.0% and the year-over-year increase in the CPI at 2.3% the “real” or inflation-adjusted funds rate is negative 0.3%.  Over the past 57 years that “real” rate has averaged about plus 1.0% which should be regarded as a “neutral” real rate.  Given a likely pickup in GDP growth this year and next and a gradual increase in the inflation rate, we regard a negative real interest rate inappropriate in today’s world.  The Fed should continue to push rates higher and gradually run off some of its longer term securities.

Stephen Slifer


Charleston, SC

Personal Consumption Expenditures Deflator

August 30, 2018

There are many different measures of inflation, but the one that the Federal Reserve considers to be most important is the personal consumption expenditures deflator, in particular the PCE deflator excluding the volatile food and energy components.

The PCE deflator rose 0.1% in both June and July.  The year-over-year increase now stands at 2.3%.

Excluding the volatile food and energy components the PCE deflator rose 0.2% in July after having risen 0.1% in June.  The year-over-year increase is now 2.0%.  This is the inflation measure that the Fed would like to see rise by 2.0%.   We think it will reach the 2.2% mark for 2018 as a whole.  This inflation gauge has gone from being far below the Fed’s inflation target to being right at target currently.

The more widely known inflation measure, the CPI ex food and energy, has been rising at a somewhat faster pace and is projected to increase 2.4% overall in 2018 with a  2.4% increase for the core rate (excluding the volatile food and energy components).  For details of this forecast see the CPI write-up.

Why the difference?  The CPI measures price changes in a fixed basket of goods each month.  The deflator captures price changes, but also changes in consumer spending habits.  If we try to save money by switching from butter to lower-priced margarine, from beef to chicken, or if builders substitute PVC pipe for more expensive copper,  the deflator would come in lower than the CPI in that particular month.  For our money, we think that the CPI which strictly measures price changes is a better barometer of inflation.  The Fed disagrees.

Stephen Slifer


Charleston, SC