Some Prices Are Up, but Is That Inflation?
The headline Consumer Price Index jumped up at an annualized rate of 4.9 percent in January, following a 5.3 percent increase in December. The 12-month growth rate is now 1.6 percent. Energy, commodity, and food prices have been exerting significant upward price pressure lately—increases in those items were responsible for roughly two-thirds of the measure’s overall increase in January, according to the BLS. Food prices spiked in January (the food at home index jumped up 9.3 percent—its largest increase since July 2008—as all six major food groupings posting increases). The price of motor fuel has risen at an annualized rate of 54 percent over the past three months.
But are these recent price increases simply relative price movements brought about by changes in supply and demand conditions, or are the increases symptomatic of a monetary impulse working its way through prices in general?
Headline inflation measures, such as the CPI, are subject to short-term volatility brought about by mismeasurement, the treatment of seasonal factors, and relative price changes that have little or nothing to do with inflation. These transitory price fluctuations may cause the CPI to give a misleading monthly signal of the inflation trend.
Price statistics that attempt to distinguish the inflation signal from noise are often called core or underlying measures of inflation. One well-known core inflation statistic excludes food and energy prices from the CPI, a statistic most economists refer to as the “core CPI.” Food and energy prices tend to be the most volatile components and they regularly cause fluctuations in the CPI that are not characteristic of the inflation trend. However, the “ex-food and energy” approach does not address transitory price fluctuations in other components of the retail market basket that is used to construct the CPI. Such fluctuations can be caused by mismeasurement and idiosyncratic shocks (like excise taxes, inclement weather, government programs to stimulate demand for certain items, and so on).
A couple of measures of underlying inflation produced by the Federal Reserve Bank of Cleveland—the median CPI and 16 percent trimmed-mean CPI—attempt to “amplify” the inflation signal by eliminating the most volatile monthly price swings (hence, decreasing the noise). What have these measures been telling us lately?
Well, the median CPI rose 2.0 percent in January, while the 16 percent trimmed-mean CPI increased 2.7 percent. These increases are roughly in line with the statistics’ longer-run (5-year) averages of about 2.0 percent. The latest numbers are somewhat of an uptick compared to recent months, however. Over the past 12 months, the median and trimmed-mean measures are hovering just above series lows set back in 1968—up just 0.8 percent and 1.0 percent, respectively.
Another way to analyze the incoming data is to look at where the price increases are coming from. Bryan and Meyer (2010) separate the consumer market basket into “flexible” and “sticky” prices. Flexible-priced items (like gasoline) are free to adjust quickly to changing market conditions, while sticky-priced items (like prices at the laundromat) are subject to some impediment or cost that causes them to change prices infrequently. As their research shows, sticky prices appear to have an embedded inflation expectations component that is useful in forecasting future inflation.
As is evident in the figure below, the flexible price series is definitely more volatile, and does appear to vary with changing economic conditions. The sticky price series has been relatively stable since 1983, usually hovering between 2.0 percent and 3.0 percent. However, over the past two years the sticky CPI has experienced a sizeable disinflation—slowing from a year-over-year growth rate of 2.8 percent in December 2007 to a low of 0.7 percent in September 2010. Since then, the sticky CPI has edged back up slightly and is now trending at a 12-month growth rate of 1.0 percent. The flexible CPI, which fell to a year-over-year growth rate of -10 percent during the depths of the last recession, has popped back up to a 12-month growth rate of 3.4 percent through January.
The flexible CPI is intriguing in that, by design, it is likely to show evidence of pricing pressure ahead of the sticky CPI. However, the series is very volatile relative to its sticky-price counterpart and likely dominated by relative price changes. As a result, inflation forecasts based on the flexible CPI perform rather poorly.
While rapid price increases in a few categories seem to have pushed up the headline CPI lately, underlying measures of inflation are relatively low and have only ticked up slightly in the past few months.