Monday, 25 of March of 2019

Economics. Explained.  

Category » Inflation

Gasoline Prices

March 20, 2019

Gasoline prices at the retail level rose $0.08 in the week ending March 18 to $2.55 per gallon.  In South Carolina gasoline prices tend to about $0.25 below the national average or about $2.30. The Department of Energy expects national gasoline prices to average $2.50 in 2019, not far from where they are currently.

The selloff in the stock market that began in October pushed oil prices lower as investors believed that global GDP growth would slow and, hence, reduce the demand for oil.  Oil prices fell to a low of about $45 per barrel.  But Saudi Arabia has cut production twice this year and, as a result, oil prices have rebounded to about $58.  The Department of Energy expects crude prices to average $56.13 this year.

Meanwhile, U.S. production  has surged from 10,900 thousand barrels to 12,100 thousand barrels per day.  As noted above, the cut in oil production by the Saudi’s has boosted the  price of oil to about $55.  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 boost production.  The Saudi’s will not permit the U.S. to increase its market share of the global markets.

The Department of Energy expects U.S. production to climb 11% from 10.9 million barrels last year to 12.3 million barrels this year and 13.0 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 appears to have arrested the recent decline in crude stocks and gotten supply and demand back into better balance..    At 1,098 million barrels crude inventories are  roughly in line with the 5-year average of 1,116 million barrels.

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 went into effect in early November.  Iranian production has not fallen too sharply yet, but the U.S.’s  goal is to reduce exports (and, hence, production) close to zero.  Thus, as we go forward Iranian output could fall sharply and push crude prices higher.

Stephen Slifer


Charleston, SC

Producer Price Index

March 13, 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 February after having declined 0.1% in both December and January.  During the past year this inflation measure (the red line) has risen 1.8%.

Excluding food and energy producer final demand prices rose 0.1% in February after having  risen 0.3% in January.  They have risen 2.5% in the past year (the pink line).  This series was steadily accelerating for a couple of years, but it has leveled off 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 rose 0.4% in February after having fallen 0.8% in January. These prices have now risen 0.6% in the past year (left scale).   Excluding the volatile food and energy categories the PPI for goods rose 0.1% in February after having climbed 0.3% in January.  During the past year the core PPI for goods (the light green line) has risen 2.2% (right scale).

Food prices declined 0.3% in February after having plunged by 1.7% 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 1.6%.

Energy prices rebounded by 1.8% in February after having fallen 3.8% in January.  Energy prices have declined 6.5% in the past year.   This drop is in large part because U.S. oil output is now surging and global demand has been slowing down.  But  OPEC countries have recently cobbled together an agreement to cut oil production.  That has stabilized oil prices for the time being although OPEC would like them to rise to the $85-90 per barrel mark.  Not going to happen with U.S. output surging.

The PPI for final demand of services was unchanged in February after having risen 0.3% in January.  This series has risen 2.4% over the course of the past year (left scale).   The jump in service goods prices late last year was 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) rose 0.3% in February after having been unchanged in both December and January.  It has climbed 2.2% in the past year.

The slowdown in producer prices was 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 was above 50.0 and steadily rising during that period of time indicated that price pressures were intensifying every single month.  However, from June through February this series has actually declined to 49.4.  This means that prices are now fairly steady.  Thus, the steady upward pressure on the PPI has begun 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 3.8% 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 modest upward pressure on inflation.  We expect the core CPI to increase  2.3% in 2019 after having risen 2.2% in 2018.

Stephen Slifer


Charleston, SC

Consumer Price Index

March 12, 2019

The CPI rose 0.2% in February after having been unchanged in each of the previous three months.  During the past year the CPI has risen 1.5%.

Food prices rose 0.4% in February after having climbed 0.2% in January.  Food prices have risen 1.9% in the past twelve months.

Energy prices rose 0.4% in February after having fallen 3.1% in January.  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have declined 5.1%.

The recent drop in energy prices is  partly related to a drop-off in demand outside the U.S., principally in China.  It also reflects a huge jump in U.S. oil production.  As a result, oil prices plunged from $76 per barrel back in October to a low of about $45 billion in early January.  However, a cut in Saudi output announced last month has lifted prices back to about $55 per barrel.

Excluding food and energy the CPI 0.1% in February after having risen 0.2% in each of the past five months.  Over the past year this so-called core rate of inflation has risen 2.1%.  We expect the core CPI will rise 2.3% 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 risen 0.1% while prices for services have risen 2.7%.

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.  Apparel prices have declined 0.8%, new cars have risen 0.3%, airfares have fallen 2.3%, televisions have declined 16.8%, audio equipment has dropped 0.5%, toys have fallen 8.8%, information technology commodities (personal computers, software, and telephones) have declined 6.1%.  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 3.2%.  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 a slight 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, productivity gains are countering much 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 1.9% rate.  We expect it to climb 2.0% 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 increases 2.3% in 2019 while the core PCE climbs 2.0%.  That compares to the Fed’s targeted rate of 2.0%.

Keep in mind that real short-term interest rates are quite low.  With the funds rate today at 2.4% and the year-over-year increase in the CPI at 1.5% the “real” or inflation-adjusted funds rate is 0.9%.  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, a rate that low is inappropriate in today’s world.  The Fed should continue to push rates somewhat higher and gradually run off some of its longer term securities, although the Fed’s anticipated two rate  hikes in 2019 will not occur until the second half of the year.

Stephen Slifer


Charleston, SC

Personal Consumption Expenditures Deflator

March 1, 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 0.1% in December after having been  unchanged in November.  The year-over-year increase now stands at 1.7%.

Excluding the volatile food and energy components the PCE deflator rose 0.2% in both November and December.  The year-over-year increase is now 1.9%.  This is the inflation measure that the Fed would like to see rise by 2.0%.   We think it will rise 2.0% in 2019 after having risen 1.9% in 2018.  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 2.2% overall in 2019 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

Gross Domestic Purchases Deflator

February 28, 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 1.6% in the fourth quarter after  having risen 1.8% in the third. Over the past year this index has risen 2.2%.

Excluding the volatile food and energy components this index rose 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 3.9% 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.  However, oil prices have now fallen sharply which should lower the headline rate of inflation for the next couple of months.  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 been unchanged in the past year while prices for services have risen 2.9%.  Hence we expect  the core CPI to climb from  2.2% in 2018 and 2.4% this year.

Stephen Slifer


Charleston, SC

Employment Cost Index

January 31, 2019

The employment cost index for civilian workers climbed at a 2.7% pace in the fourth quarter after having risen at a 3.0% pace in the third quarter.  Over the course of the past year it has risen 2.9%.  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 3.9% 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 2.4% rate in the fourth quarter after rising at a 3.6% pace in the third quarter.  Over the course of the past year wages have been rising  at a 3.0% pace.  Wage pressures are beginning to accelerate gradually.

Benefits climbed at a 2.6% pace in the fourth quarter after rising 1.8% in the third quarter.   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 0.9% in the past year as compensation rose 2.2% while productivity increased by 1.3%.    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


Charleston, SC