Where is the non-Energy Inflation?

This morning the BLS released its estimate of producer price inflation for December:

The Producer Price Index for Finished Goods rose 0.9 percent in December, seasonally adjusted, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. This increase followed a 0.7-percent decline in November and a 0.7-percent gain in October. Prices for finished goods other than foods and energy advanced 0.1 percent in December, the same rate as in November.

…From December 2004 to December 2005, finished goods prices rose 5.4 percent, following a 4.2-percent increase in 2004. The index for finished energy goods climbed 23.9 percent in 2005, after moving up 13.4 percent in the preceding calendar year. Conversely, prices for finished goods other than foods and energy rose 1.7 percent in 2005, following a 2.3-percent gain in 2004.

It continues to be the case that dramatically higher energy costs are not feeding through into higher costs of other goods and services. The following chart illustrates that there have now been three full years of rapid increases in energy prices that have not fed through into higher non-energy producer prices.

Unlike during earlier energy shocks, when increases in the price of oil typically led to inflation in other types of goods and services, this time the increase in the price of oil has led only to a change in the relative price between energy and non-energy products.

Why haven’t firms passed on their higher energy costs? Presumably it’s because they haven’t been able to charge higher prices, not because they haven’t wanted to. This could be the case if the demand for non-energy products by firms has fallen a bit as firms have had to spend more of their budgets on energy products. In other words, firms are simply shifting the allocation of their spending away from non-energy products and toward energy products.

One interpretation of this phenomenon is that it is a symptom of weak aggregate demand. If aggregate demand were higher, then firms would be in a better position to pass on their higher energy costs. The fact that the discrepancy between energy costs and non-energy costs has persisted and even widened in recent months may therefore be a sign of a slowing economy.