Monday, 25 of March of 2019

Economics. Explained.  

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

NumberNomics

Charleston, SC


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