8% Inflation on the Horizon?
After dissing the CPI in one of my previous posts (see here), I am bringing it back today to give it the attention it deserves. There are problems with most statistics but that doesn’t mean we shouldn’t use them only that we should use them with caution.
Today, the Bureau of Labor Statistics released the latest consumer price inflation figures for June 2008 and they are not a pretty sight. The statistic that was used the most in the press today was 1.1% – that is the inflation of headline-CPI-U (i.e., all urban consumers; including food and energy) in the month of June. This works out to a 5% un-seasonally adjusted annual inflation rate for the 12 months ending June 2008 – way above the target rate of close to 2% unofficially set by the Fed.
The markets went up today since Wells Fargo reminded everyone not to throw babies out with the bathwater in times of undue pessimism. However, listening to Bernanke’s comments to Congress today and looking at the inflation figures in more detail, it’s important not to get carried away and think everything is peachy. What do I mean?
Inflation has ramped up significantly over the past three months and unless something changes in interest rate policy, global middle class consumption or some other supply/demand variable, it will not be slowing down soon.
A look at the details is revealing:
In the month of June alone, the energy component of CPI-U increased 6.6%; food increased 0.8%; transportation increased 3.8% and no component grew more slowly than in May 2008.
If you take the past three months and calculate the compound annual rate (April*May*June to the fourth power) – you get an annual headline CPI of 7.9%. Not a pretty picture.
At some point, consumption has to give but 7.9% is quite low by world standards and was common in the U.S. before the mid-80s – nobody knows what will happen in the months ahead, but I am just pointing out that it is not an impossibility. If interest rates don’t rise soon (and in fact, most pundits don’t expect interest rates to rise until the end of the year), I don’t see low inflation on the horizon.
Here are the details from BLS:
So the question is whether the change in CPI-U accounts for substitution effects – e.g. if energy prices go up, eventually people will adjust by using less energy. I suspect that the reaction time to price changes is often longer than one or two months, so the conclusions drawn from the current numbers might be exaggerated. I believe the C-CPI-U (which was so roundly dismissed by Keving Phillips) is designed to try and account for such substitution effects. I have no idea how effective it is.
Nice background.
Gaurav
July 16, 2008 at 4:18 pm
It seems that the C-CPI-U is designed to try to account for substitution effects. At the moment I think they only have preliminary figures (maybe they require a lag before figuring out the substitution effects?). April, May and June of 2008 all have different values from the CPI-U with April and May higher than the CPI-U and June lower (.5%, .65% and .75% respectively). The annual compound rate for the last three months is also 7.9%.
David
July 16, 2008 at 5:05 pm