Sunday, 30 of April of 2017

Economics. Explained.  

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

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