Sunday, 30 of April of 2017

Economics. Explained.  

Category » Inflation

Employment Cost Index

April 28, 2017

The employment cost index for civilian workers rose at a 3.1% annual rate in the first quarter after having risen 1.9%rate in fourth quarter.  Over the course of the past year it has risen 2.4%.  Thus, the labor market is slowly beginning to get tighter, and to attract the workers that they want employers are having to work employees longer hours, and offer higher wages and/or more attractive benefits packages.

With the unemployment rate at 4.5% and full employment also presumably at 5.0%, it is not surprising that we are beginning to see a hint of upward pressure on compensation.

Wages climbed at a 3.2% rate in the first quarter versus 1.9% pace in  fourth quarter.  Over the course of the past year wages have been rising  at a 2.4% pace.  Wage pressures are beginning to accelerate gradually.

Benefits climbed at a 2.7% pace in the first quarter versus 1.8%  in the fourth quarter.   As a result, the yearly increase in benefits is now 2.2%.

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 5.0% more money but you are 5.0% more productive, I really don’t care.  In that case, unit labor costs were unchanged.

Currently, unit labor costs  have risen 2.0% in the past year as compensation rose 3.0% while productivity increased by 1.0%.   Such an increase in ULC’s is consistent with an inflation rate somewhat higher than the Fed’s desired target rate of 2.0%.    If that is the case, something is clearly different.  Productivity gains are no longer offsetting the increase in labor costs. The Fed should continue to raise interest rates.

Stephen Slifer


Charleston, SC

Gasoline Prices

April 26, 2017

Gasoline prices at the retail level rose $0.01 in the week ending April 24 to $2.45 per gallon.   In the low country of South Carolina gasoline prices tend to about $0.25 below the national average or about $2.20. The Department of Energy expects national gasoline prices to average $2.39 this year — almost exactly where they are currently.

As the price of gasoline declined the economy got a tailwind. However,  oil prices today are 13% higher today than they were a year ago.  Hence, the tailwind effect on the economy has run its course but has not yet turned into a headwind.

Crude oil prices are currently about $50.00 mark.  The Energy Information Agency predicts that crude prices will average $52.24 in 2017.  As crude oil and gas prices have leveled off the underlying inflationary pressures have become more apparent.

The number of oil rigs in service dropped 79% to 404 thousand  after reaching a peak of 1,931 wells in September 2014.  However, the number of rigs in operation has actually rebounded in recent months to 857 thousand.  Thus,  higher crude oil prices are encouraging some drillers to step up slightly the pace of production.

While the number of oil rigs in production has been cut by 79% between late 2015 and the middle of last year, oil production has declined much less than that.  The Department of Energy expects production to average 9.0 million barrels per day in 2017.  We seem to be on track for close to that estimate.

How can the number of rigs go down but production be relatively steady?  Easy.  Technology in the oil sector is increasing rapidly which allows producers to boost production while simultaneously shutting down wells.  For example, output per oil rig has increased by 35% in the past twelve months.  Put another way, a year ago some frackers could not drill profitably unless crude oil prices were about $70 per barrel.  Today that number has declined to about about $44 per barrel.  Six months from now that number will be lower still.

While oil inventories gradually declined for most of 2016 the recent increase in production has caused inventory levels to rebound.  While oil prices might remain firm through midyear, the excessive amount of available crude will ultimately push gas prices lower.

In December OPEC agreed to cut production, but it remains to be seen how meaningful the cut will turn out to be.  In the past, various countries would begin to cheat and the whole thing would unravel.  Furthermore, as oil prices rise U.S. producers will return in droves and prices will once again begin to fall.

Stephen Slifer


Charleston, SC

Consumer Price Index

April 14, 2017

The CPI declined 0.3% in March after having risen 0.1% in February after having jumped 0.6% in January .  This was the first drop in the CPI since February 2016.  During the past year the CPI has risen 2.4%.  While much of the decline can be attributed to the energy component which  fell 3.2% (retail gas prices in particular which plunged 6.2%).  However, prices for wireless telephone services, used cars and trucks, new vehicles, and apparel contributed to the surprising drop in the CPI excluding the volatile food and energy components.

Food prices rose 0.3% in February after having risen 0.2% in February and 0.1% in January.  Food prices have risen 0.3% in the past twelve months.

Energy prices fell 3.2% in March after having declined 1.0% in February after having  jumped 4.0% in January .   Over the past year energy prices have risen 10.9%.  As noted earlier this drop was caused by a very sharp 6.2% contraction in retail gasoline prices.  But subsequent to the March decline pump prices appear to have risen in the past several weeks, so the March declined should prove to be short-lived.

Excluding the volatile food and energy components, the so-called “core” CPI declined 0.1% in March after having been unchanged in January after having risen 0.2% in both November and December.  The year-over-year increase now stands at 2.0%.  The March drop in the core CPI was a surprise and was the first decline in this series since January 2010.  Wireless telephone services which fell 7.0% led the decline.  But prices for used cars and trucks continued to fall (-0.9%), new cars declined 0.3%, and apparel fell 0.7%.  While surprising, the March decline does not alter the expectation that the core CPI will continue to trend upwards in 2017 — although the acceleration should be gradual.

The core rate of inflation will have an upward bias in 2017 in part because of what has been happening to shelter and medical care.

Shelter costs rose 0.1% in March after having risen 0.3% in February and 0.2% in January.  In the  past year they have climbed 3.5%.  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.  It has been a long time since we have any component of the CPI show any upward pressure, so this category needs to be watched particularly since it makes up 33% of the overall index.


Medical costs rose rose 0.1% in both February and March after having increased 0.2% in December and January.  The recent increases have been led by a run-up in the hospital services index, an increase in prescription drug prices, and a jump in the price of health insurance.  Over the past year medical costs have increased 3.5%.  They continue to climb and will put upward pressure on the core rate of inflation in 2017.

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 1.6% rate and is poised to head higher.  The Fed has a 2.0% inflation target.  However, going forward we have to watch out for the acceleration 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.  We also have to watch rising medical costs.

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 pricey 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 CPI currently is at 2.0%.  However, with the economy growing steadily, rents rising, and the unemployment rate falling, the inflation rate should pick up during 2017 and rise by 2.4% in 2017 and 2.7% in 2018.  And because the core PCE increases at a rate slightly slower than the core CPI, the core PCE should increase  2.0% in 2017 and  2.2% in 2018.  Both rates are trending higher.

Stephen Slifer


Charleston, SC


April 13, 2017

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 declined 0.1% in March after having risen 0.3% in February and 0.6% in January.  During the past year this inflation measure has risen 2.3%  which is the largest 12-month increase since May 2014 which is, not surprisingly, about that point in time when oil prices began to plunge.

Excluding food and energy producer prices rose 0.3% in February after having risen 0.4% in January.  They have risen 1.6% since March of last year.  However, in the past three months this series has risen at a 2.5% pace so even apart from the upswing in energy prices, the prices of all goods have begun to accelerate.

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

The PPI for final demand of goods was unchanged in March after having risen 0.3% in February and 1.0% in January. These prices have now risen 4.0% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods rose 0.4% in March after having risen 0.1% in February and 0.4% in January.  During the past year the core PPI for goods has risen 2.3% (right scale).  It has been steadily accelerating for more than a year.

Food prices were jumped 0.9% in March after having risen 0.3% in February and after having been unchanged in January.  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 risen 0.3%.

Energy prices declined 2.9% in March after having increased 0.6% in February and 4.7% in January..  Energy prices have risen 15.3% in the past year.  The earlier drop was due to a sharp increase in oil production in the U.S., and weaker demand from China.  However, crude oil inventories have reached a record high level and at some point the price of crude oil should begin to decline.

The PPI for final demand of services declined 0.1% in March after having risen 0.4% in February and 0.3% in January.  This series has risen 1.5% over the course of the past year (left scale).  Changes in this component largely reflect a drop in margins received by wholesalers and retailers (apparel, jewelry, and footwear in particular).  The PPI for final demand of services excluding trade and transportation fell 0.1% in March after having risen 0.5% in February and having declined 0.1% in January .  It has climbed 1.5% during the past year.

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 4.5%, the labor market is at full employment.  At that point wages pressures are sure to rise, and once that happens firms are almost certain to pass that along to the consumer in the form of higher prices.

Some upward pressure on labor costs, rents, and medicare care will further increase the upward pressure on inflation.  We expect the core CPI to increase 2.5% in  2017 and 2.7% in 2018.

Stephen Slifer


Charleston, SC

Personal Consumption Expenditures Deflator

March 31, 2017

Personal Consumption Expenditures Deflator

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 February after having risen 0.4% in January.  The year-over-year increase now stands at 2.1% but in the past three months it has risen at a 2.9% pace.

Excluding the volatile food and energy components the PCE deflator rose 0.2% in February after having risen 0.3% in January.  The year-over-year increase is now 1.8%.  As noted above, this is the inflation measure that the Fed would like to see rise by 2.0%.   We think it will reach the 2.0% mark by the middle of this year and 2.3% by the end of 2017.  While this is not a bad rate of inflation, the reality is that it has gone from being below the Fed’s inflation target to being slightly above its target.  The Fed is likely to raise the funds rate three  times in 2017 which would lift the funds rate to the 1.25% mark (which is still very low).

Personal Consumption Expenditures Deflator -- Projected

The more widely known inflation measure, the CPI ex food and energy, has been rising at a somewhat faster 2.2% pace and is projected to increase 2.8% in 2017.

CPI -- Projected

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, 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