What Inflation?

April 16, 2008

U.S. consumer price inflation data are developing a serious credibility problem. All consumer prices were flat in February, then up 0.3% last month. That’s the most comprehensive CPI measure, including both energy and food but also consumer electronics where quality enhancements have been depressing prices for years. The 12-month rate of CPI inflation held at 4.0% in March and was lower than the pace in November, December and January. Core inflation, which excludes food and energy, has been steady at either 2.3% or 2.4% since November and has ranged between 2.1% and 2.5% during the past year. The rationale for the Fed paying most attention to a measure of core inflation is that food and energy costs are volatile, that they are not affected by monetary policy, and that spikes and dives in these items tend to even out such that core inflation in the long run approximates total inflation. The last of these rationalizations has not been true in recent years. Commodity price inflation has been secular, not cyclical. Moreover, in recent times, food and energy have exerted a disproportionate influence upon perceptions of inflation. That’s because these items are confronted on a weekly and often daily basis. Many other items in the typical consumer purchasing basket that are rising not as sharply as food or energy are also bought far less frequently. One salesman who drives over 100 miles daily argued stenuously with me not long ago that the inflation he is experiencing is closer to 12% than 2%. Change perceptions of inflation, and it’s not a great leap to changing expectations about future inflation. Thus far, the erosion of the worker’s wage bargaining power and disinflationary global competition have done a decent job of forestalling a quantum deterioration of inflation. That’s usually how price stability dissipates, not in a gentle incline but all of a sudden. The labor market will weaken further in coming months, but globalization has transformed from an inflation reducer to an inflation amplifier. The CPI numbers may not show it, but slumping consumer confidence indicates that households are not coping well with the sharp rise of goods and services they confront each day.


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