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On Target

The CPI was flat in April, largely because falling gasoline prices offset modest increases elsewhere in the basket. But the real news in the latest price report was that on a year-over-year basis the CPI is up just 2.3 percent as of the end of April, continuing its slowdown since it hit a high of 3.9 percent last September.

April Price Statistics

Consumer Price Index Percent change, last
1 mo.a 3 mo.a 6 mo.a 12 mo. 5 yr.a 2011 average
All items 0.4 3.0 2.1 2.3 2.2 3.0
Excluding food and energy (core CPI) 2.9 2.3 2.2 2.3 1.7 2.2
Medianb 2.3 2.1 2.3 2.4 1.9 2.3
16% trimmed meanb 1.9 2.0 2.0 2.3 2.0 2.6
Sticky CPI 2.4 2.1 2.4 2.2 2.0 2.1

a Annualized.
b Calculated by the Federal Reserve Bank of Cleveland.
c Author’s calculations.

Source: Bureau of Labor Statistics.

This is the first month since October 2009 that the longer-term (12-month) trend in the CPI has been at or below the trend in the core CPI. In fact, just about every CPI-based underlying inflation measure we track was within a tenth of a percent of 2.3 percent. Moreover, the recent trajectories of these measures haven’t signaled much of a departure from their respective 12-month growth rates.

Consumer Price Index

Importantly, a 2.3 percent growth rate in CPI-based inflation measures is roughly equivalent to a 2.0 percent trend in PCE-based inflation measures. This is due to a variety of differences between the two price indexes (here’s a quick overview of the differences). Given that the medium-term explicit inflation target of the Federal Open Market Committee (FOMC) is 2.0 percent on PCE inflation, measured inflation is already “on target.” The Committee also appears to be expecting roughly “on target” inflation over the next few years, as the central tendency of its PCE inflation projections remains within a few tenths of 2.0 percent throughout the forecast horizon.

Despite worries about an impending bout of higher inflation or another deflation scare, there is some recent evidence that appears to support the more sanguine view that inflation will remain fairly close to target.

First, the underlying CPI-component-price-change distribution hasn’t moved around much in recent months. This is consistent with the view that inflation has been roughly stable lately, and that the aggregate readings haven’t been driven by one or two outliers in the data.

CPI Component Price Change Distribution

Second, a measure of the connection between wages and inflation suggests that inflation is still somewhat subdued. While that connection—that increases in compensation will bid up retail prices and feed into an increase in inflation—is contested because the direction of causality is not clear, analysts often refer to it for clues about where inflation is headed. Setting aside the validity of the connection for the moment, it does appear that an oft-cited measure of compensation growth is highly correlated with the sticky CPI—a forward-looking inflation measure that comprises the most persistent (or stickiest) components in the retail market basket. The correlation coefficient between the sticky CPI and the Employment Cost Index (ECI) for private workers is 0.87. If wage pressures do indeed cause inflation, then the recent trend in the ECI suggests, if anything, a slightly disinflationary signal. The ECI is up 2.1 percent on a year-over-year basis, compared to its average growth rate over the past 10 years of 2.8 percent.

Employment Costs and Sticky Inflation

Finally, household inflation expectations still appear stable. Despite a modest blip up in the median year-ahead expectation (likely due to the recent gasoline-price increase), which has since ebbed, longer-run (5–10-year-ahead) expectations haven’t moved much at all. In May, the median longer-run inflation expectation stood at 3.0 percent, 0.1 percentage point above its 10-year average.

Employment Costs and Sticky Inflation

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