Sunday, 25 of June of 2017

Economics. Explained.  

Consumer Price Index

May 14, 2017

The CPI fell 0.1% in May after having risen 0.2% in April.  During the past year the CPI has risen 1.9%.  The year-over-year increase climbed to 2.8% in February before settling back in March and April.  A drop in energy prices was the primary contributor to the monthly decline overall.  Excluding food and energy the CPI rose 0.1% for the second consecutive month.  Over the past year this so-called core rate of inflation has risen 1.7%.

Food prices rose 0.1% in May after having risen 0.2% in April.  Food prices have risen 0.9% in the past twelve months.

Energy prices declined 1.7% in May after having risen 1.1% in April .  These prices are always volatile on a month-to-month basis.   Over the past year energy prices have risen 9.2%.  Energy prices should be relatively flat between now and yearend.

Excluding the volatile food and energy components, the so-called “core” CPI rose 0.1% in both April and May.  The year-over-year increase now stands at 1.7%.  The year-over-year increase in the core CPI had risen to as high as 2.3% in January before retreating.  But a lot of this reflects a price war amongst telecommunications firms and thereby distorts the overall run-up.

The core rate of inflation will have an upward bias in 2017 in part because of what has been happening to shelter and gradually rising labor costs which reflects the tightness in the labor market.

Shelter costs rose 0.2% in May after having risen 0.3% in March.  In the  past year they 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.  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.


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 1.5% 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 1.7%.  However, with the economy growing steadily, rents rising, and the unemployment rate falling, the inflation rate should pick up during 2017 and rise by 2.1% 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  1.8% in 2017 and  2.2% in 2018.  Both rates are trending higher.

Keep in mind that real short-term interest rates are negative.  With the funds rate today at 1.0% and the year-over-year increase in the CPI at 1.9% the “real” or inflation-adjusted funds rate is negative 0.9%.  Over the past 57 years that “real” rate has averaged about 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.

Stephen Slifer


Charleston, SC

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