Tuesday, 16 of July of 2019

Economics. Explained.  

Category » Inflation

Producer Price Index

July 12, 2019

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 0.1% in both May and June after having risen 0.2% in April.  During the past year this inflation measure (the red line) has risen 1.6%.

Excluding food and energy producer final demand prices rose 0.3% in June after having risen 0.2% in May and 0.1% in April.  They have risen 2.3% in the past year (the pink line).  This series was steadily accelerating for a couple of years, but it has begun to drift lower in the past 12 months or so.

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

The PPI for final demand of goods fell 0.4% in June after having declined 0.2% in May after having increased 0.3% in April. These prices have now risen 0.1% in the past year (left scale).   Excluding the volatile food and energy categories the PPI for goods was unchanged in April, May, and June.  During the past year the core PPI for goods (the light green line) has risen 1.4% (right scale).

Food prices rose 0.6% in June after having fallen 0.3% in May and 0.2% in April.  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 2.2%.

Energy prices fell 3.1% in June after having declined 1.0% in May after having risen 1.8% in April.  Energy prices have fallen 7.0% in the past year.   Output in Venezuela and Iran has been falling steadily and Saudi Arabia recently cut its oil output in an effort to boost prices, but U.S. production has continued to surge to a new record high level of 12.4 million barrels per day and that increase in output has more than countered the OPEC shortfall.  As a result, oil prices declined to about $53 per barrel.  However, the recent attack by Iran on an oil tanker in the Persian Gulf has lifted crude prices to $58.  That increase will be reflected in the data for next month.

The PPI for final demand of services rose 0.4% in June after having risen 0.3% in May and 0.1% in April.  This series has risen 2.5% over the course of the past year (left scale).   The PPI for final demand of services excluding trade and transportation (the light blue line) was unchanged in June after having jumped 0.5% in May after having increased 0.3% in April.  It has climbed 2.2% in 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 3.6% the labor market is well beyond full employment.  As a result, wages pressures have begun to climb, but the resulting upward pressure on inflation has been countered by an increase in productivity.  Unit labor costs, labor costs adjusted for the increase in productivity, have fallen 0.8% in the past year.  Compensation climbed 1.5% during that period of time but that increase was almost entirely offset by a 2.4% increase in productivity.  No wonder the seemingly tight labor market is not putting upward pressure on inflation — the increase is being entirely offset by an increase in productivity.  That means that firms have no real incentive to raise prices — workers have earned their fatter paychecks.

We expect the core CPI to increase  2.3% in 2019 after having risen 2.2% in 2018.

Stephen Slifer

NumberNomics

Charleston, SC



Consumer Price Index

July 11, 2019

The CPI rose 0.1% in both May and June after having risen 0.3% in April and having risen 0.4% in March.  During the past year the CPI has risen 1.7%.  The overall index levels for May and June were held in check by a decline in energy prices.

Food prices rose 0.1% in June after having risen 0.3% in May.  Food prices have risen 1.9% in the past twelve months.  These prices tend to be lumpy with increases reported for a few months followed by several months of declining prices.

Energy prices declined 2.3% in June after having fallen 0.6% in May.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have fallen 3.4%.

The drop in crude oil prices in the past couple of months reflected a huge jump in U.S. oil production.  Oil output has fallen sharply in both Venezuela and Iran and the Saudis have also curtailed output.  However, a huge pickup in U.S. output has caused prices to decline. But the recent attack by Iran on an oil tanker in the Persian Gulf has ratcheted crude prices higher which will get reflected in the July data.

Excluding food and energy the CPI rose 0.3% in June after having climbed 0.1% in each of the previous four months.  Over the past year this core rate of inflation has risen 2.1%.  We expect the core CPI will increase 2.3% in 2019 as higher prices on goods imported from China will push this index higher in the months ahead.

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 risen 0.2% 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 or fallen for almost every major category in the past year.  Apparel prices have declined 2.9%, new cars have risen 0.9%, airfares have risen 0.9%, televisions have declined 18.6%, audio equipment has  risen 0.9%, toys have fallen 8.4%, information technology commodities (personal computers, software, and telephones) have declined 6.7%.  Prices for all of these items are widely available on the internet and can be used as bargaining chips with traditional brick and mortar retailers.

In sharp contrast prices of most services have risen.  Specifically, prices of services have risen 2.8% in the past year.  The increase in this  broad category has been led by shelter costs which 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.

The CPI, both overall and the core rate, will be relatively steady  in the months ahead.  Steadily rising shelter prices, gradually rising labor costs, and higher prices on goods being imported from China will tend to boost the CPI.  But on the flip side, productivity gains are countering all of the increase in labor costs, and the internet is keeping a lid on the prices of goods.  We look for an increase in the core CPI of 2.3% 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 1.6% rate.  We expect it to climb 1.9% in 2019.  The Fed has a 2.0% inflation target.

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 should increase 2.3% in 2019 while the core PCE climbs 1.9%.  That compares to the Fed’s targeted rate of 2.0%.

Given sustained growth in GDP growth this year and the inflation rate being close to target, there is no need for the Fed to alter the level of the funds rate.  However, recent rhetoric from Fed officials suggest that they could choose to lower rates slightly — beginning perhaps at the end of this month — by the end of the year.

Stephen Slifer

NumberNomics

Charleston, SC


Gasoline Prices

July 10, 2019

Gasoline prices at the retail level rose $0.03 in the week ending July 8 to $2.74 per gallon.  Gas prices declined for seven consecutive weeks by a total of $0.25 before rising $0.09 in the past two weeks.  In South Carolina gasoline prices tend to about $0.25 below the national average or about $2.49. The Department of Energy expects national gasoline prices to average $2.64 in 2019, slightly lower than where they are currently.  

As a result of production declines in Venezuela, Iran, and Saudi Arabia, oil prices climbed to $63 a couple of weeks ago before retreating to $52.  But Iran’s firing on oil tankers and escalating tensions in the Mideast have sharply boosted crude prices to $58.00.  The Department of Energy expects crude prices to average $59.58 this year.

Crude oil output in both Venezuela and Iran has declined markedly.  Venezuela’s oil output has been falling steadily for the past couple of years and is showing no sign of recovering.   The Iranian sanctions went into effect in early November.  Iranian production has since fallen sharply.  The U.S.’s  goal is to reduce exports (and, hence, production) close to zero.

Meanwhile, U.S. production  has surged from 10,900 thousand barrels to 12,300 thousand barrels per day.  The cut in oil production by the Saudi’s combined with reduced production in Venezuela and Iran have boosted the  price of oil to about $58.  The Saudi’s would like it to climb to $90, or at least $85, per barrel to ensure that their budget deficit remains in balance.  That is not going to happen.  As prices rise U.S. drillers will quickly boost production.  At the moment the impressive increase in U.S. production is countering the cutbacks from Venezuela and Iran.  The Saudi’s share of global production has been falling steadily for the past couple of years.  However, the Saudis cannot allow its market share to continue to slide.

The Department of Energy expects U.S. production to climb 13% from 11.0 million barrels last year to 12.4 million barrels this year and  to 13.3 million barrels per day in 2020.  The U.S. became the world’s largest oil producer in March of last year and the gap between U.S. production and that of Russia, and Saudi Arabia will widen in 2019 and 2020.

The cut in Saudi production combined with reduced production in Venezuela and Iran  appears to have  gotten supply and demand back into better balance.    At 1,104 million barrels crude inventories are  in line with the 5-year average of 1,116 million barrels.

Stephen Slifer

NumberNomics

Charleston, SC


Personal Consumption Expenditures Deflator

une 28, 2019

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 0.2% in May, 0.3% in April,and 0.2% in March.  The year-over-year increase now stands at 1.5% although in the past four months it has risen at a 2.8% pace.

Excluding the volatile food and energy components the PCE deflator rose 0.2% in both April and May after having risen 0.1% in March.  The year-over-year increase is now 1.6% but in the past three months it has risen at a 2.0% pace.  This is the inflation measure that the Fed would like to see rise by 2.0%.   We think it will rise 1.9% in 2019 after having risen 2.0% in 2018.  This inflation gauge was approaching the Fed’s inflation target last year but has slipped a bit lately.  However, the newly imposed tariffs on imports of goods from China should  boost this index somewhat in the second half of this year so that the year-over-year increase for 2019 should be 1.9% which is close to the Fed’s 2.0% target.

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 2019 with a  2.2% 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

NumberNomics

Charleston, SC


Gross Domestic Purchases Deflator

June 27, 2019

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 0.8% in the first quarter after having climbed 1.7% in the fourth quarter. Over the past year this index has risen 1.7%.

Excluding the volatile food and energy components this index rose 1.3% after having risen 1.8% in the fourth 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 will inch upwards in 2019.  With the unemployment rate at 3.8% the economy is at full employment which should boost wages.  However, much of the upward pressure on wages is being offset by an increase in productivity.  A very short supply of available rental properties is boosting rents and helping to push inflation higher.  Oil prices fell sharply in the fourth quarter and have rebounded, but should be fairly steady for the balance of the year.    One other 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 declined 0.2% in the past year while prices for services have risen 2.8%.  Hence we expect  the core CPI to climb  2.3% this year after having risen 2.2% in 2018.

Stephen Slifer

NumberNomics

Charleston, SC


Employment Cost Index

April 30, 2019

The employment cost index for civilian workers climbed at a 3.0% rate in the first quarter after climbing at a 2.7% pace in the fourth 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 3.8% and full employment 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 3.0% race in the first quarter following a 2.4% gain in the fourth quarter.  Over the course of the past year wages have been rising  at a 2.8% pace.  Wage pressures are beginning to accelerate gradually.

Benefits climbed at a 2.6% pace in both the the fourth quarter of last year and in the first quarter of 2019.   As a result, the yearly increase in benefits is now 2.7%.

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 1.0% in the past year as compensation rose 2.8% while productivity increased by 1.8%.    We expect compensation to climb to about the 3.7% mark this year, 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

NumberNomics

Charleston, SC