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Brent Meyer |

Economist

Brent Meyer

Brent Meyer is a former economist of the Federal Reserve Bank of Cleveland.

03.11.11

Economic Trends

What to Make of Rising Gas Prices and Falling Household Energy Prices

Brent Meyer

Yes, oil and commodity prices are increasing, and we are starting to see that increase expressed in retail prices. Motor fuel prices jumped up at an annualized rate of more than 50 percent in January, and they have risen nearly 14 percent over the past year. But why don’t we hear about other dramatic changes in relative prices—in the opposite direction—like car and truck rentals (down 28.4 percent) and infants’ and toddlers’ apparel (down 20.5 percent)?

Perhaps it is because increasing prices at the pump are particularly painful for the average consumer. Motor fuel’s share of the consumer market basket that is used to compute the Consumer Price Index (CPI) is about 5 percent, making it a comparatively large component. Or perhaps it is the frequency with which we purchase gasoline, making price increases somewhat maddening. Still, the big dive that piped household gas and electricity prices took in January was barely acknowledged, though their weight in the CPI, roughly 4 percent, is similar to motor fuels. Their prices fell 7.2 percent in January and they are actually down 0.7 percent over the past year (even though the winter was harsher than usual).

Lately, many are suggesting that the increase in the relative price of gasoline and other commodities is a sign of incipient hyperinflation. But that doesn’t make sense given the decreases in other prices, like household energy prices. Why wouldn’t they be some signal of deflation?

The current situation illustrates why it’s not a good forecasting practice to track price changes of one or a few items and use them as a predictor of future inflation. For example, gasoline prices were also high in mid-2008, running at a year-over-year growth rate of 38.2 percent. Was this some sign that high inflation was on its way? Not really. By March 2009, the 12-month percent change in the headline CPI was below zero, largely because energy prices had reversed course.

Prices for individual items change for a variety of reasons—supply and demand conditions, excise taxes, and weather disturbances, to name a few. Inflation, unlike a relative price increase, is an impulse that affects all prices, not just some. So when trying to interpret the latest data, a look at the entire distribution of price changes may often be more informative than looking at just a few prices.

For example, comparing the average weighted price-change distribution over last 12 months with the past 10 years gives us a look at the shape of the distribution, whether or not there are some extreme outliers, and, importantly, where most of the mass is. Interestingly, price changes in the consumer market basket, if anything, looks more disinflationary over the past 12 months when compared to the 10-year average. On average over the past 12 months, roughly half of the overall index has exhibited price changes in the range of −1 percent and 2 percent, compared to about 30 percent on average over the last decade.

But eyeballing price-change distributions for an inflation signal is fairly messy. To characterize changes in consumer prices in the hope of seeing such a signal, there are a few statistics we could examine. First is the headline CPI, which is a weighted average of all the prices in the consumer market basket. However, the headline CPI is somewhat noisy and subject to the influence of volatile monthly price swings. In January, for example, energy commodities and food accounted for most—over two-thirds—of the CPI’s increase, according to the Bureau of Labor Statistics.

Another set of price statistics that attempt to lessen the noise associated with volatile relative price changes is often referred to as “core” inflation measures or measures of underlying inflation. The BLS produces an “ex-food and energy” measure of consumer prices, as food and energy prices are historically the most volatile components. Some view this measure as unpalatable (especially when food and energy prices are on the rise). 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 on either end of the price-change distribution (decreasing the noise).

Benefiting from a clearer signal, forecasts based on the median and 16 percent trimmed-mean measures outperform those that use the headline or “core” CPI. And lately these measures are telling us that underlying inflation still looks a little soft. Despite a modest uptick in January, the 12-month growth rates in the median and trimmed-mean measures are trending near 1.0 percent. While near-term (3-month) growth rates have edged up a little, they are still ranging below their respective longer-term (5-year) trends.

January Price Statistics

Percent change, last
1 mo.a 3 mo.a 6 mo.a 12 mo. 5 yr.a 2010 average
Consumer Price Index
All items
4.9
3.9
3.2
1.6
2.1
1.4
Less food and energy
2.1
1.4
1.0
1.0
1.9
0.6
Medianb
2.0
1.5
1.3
0.8
2.1
0.7
16% trimmed meanb
2.7
1.8
1.4
1.0
2.0
0.8

a. Annualized.
b. Calculated by the Federal Reserve Bank of Cleveland.
Sources: U.S. Department of Labor and Bureau of Labor Statistics.