CORE CPI
I have reported on this in previous years, but in the first quarter the increase in the not seasonally adjusted (NSA) core CPI was the smallest increase since the early 1960s. Moreover, the 2010 increase was only 0.5%, or less than half the average increase of 1.2% from 2000 to 2009.
Why is this important? In a low inflation world firms tend to raise prices once a year — typically at the start of the year or season. Consequently, in the not seasonally adjusted core CPI over half the annual increase occurs in the first quarter. Actually, in recent years the first quarter share has even been larger than the 55% share since the early 1990s. Moreover, if the first quarter change is less than the prior years change, than the annual change is generally less than in the prior year. This very small increase in the first quarter NSA core CPI strongly implies that in 2010 the annual increase in the core CPI will be significantly smaller than in 2009.
Given the extremely modest increase in the first quarter NSA core CPI virtually the only acceleration in inflation in 2010 is likely to stem from food or fuel. We are all familiar with the risk to the recovery and inflation from oil, so there is not much I can add here. The DOE expects the spring switch over to more gasoline use to develop without significant refinery shortages. Concerns are being raised by the recent rise in food prices, especially in the PPI. Yes, meat and vegetable prices have risen in recent months, but it is hard to be too concerned about food inflation as long as prices of the big four major crops of corn, wheat, rice and soybeans appear to be well under control.
Note that a lower core CPI would be consistent with the typical cyclical pattern as the lowest core inflation numbers generally occur in the first year or two of a recovery.
“…the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.”
The Fed continues to link resource use rates to price in its highest-profile policy statement. The level of confidence expressed in price stability hasn’t changed, though I suspect that has a lot to do with having avoided discussion of deflation risks. The discussion of the price stability outlook would be changing along with the economic outlook, if Fed officials had been willing in recent quarters to more openly discuss the potential for deflation.
I assume that “core inflation” is CPI ex food and energy? There are other measures, but I don’t think they’d lead to dramatically different conclusions. Inflation really is subdued. See http://www.kc.frb.org/PUBLICAT/ECONREV/PDF/2q01clar.pdf
Two caveats — both with regard to the metric rather than reality:
First – Energy costs really have gone up substantially in the past year and may go up a bit more possibly depending more on the world economy than the US economy. Core CPI doesn’t include energy costs directly. But it certainly appeared in the 1970s that energy price increases were linked to the cost of just about everything — including food. While transportation costs show up immediately, I believe — can’t prove it — that it takes a while for many effects of energy price increases to filter through the economy and show up in the price of food, retailing, costs of manufacture etc. There may be a modest inflationary pressure there.
Second – As I understand it, the largest component of CPI is Owner Equivalent Rent (OER). OER looks to be a very ill behaved number. During the period when housing prices were dropping by double digits and rents in many areas were also dropping by appreciable amounts, OER continued to increase. I don’t think it’s a totally hopeless number, but I think that it probably has a large built in time lag and probably tends to tell us what was happening 18-30 months ago rather than what was happening last month. We know what was happening 18-30 months ago (October 2007-Octobert 1008). The economy had driven off a cliff and was in free fall. I suspect what that tells us is that Core CPI is going to tend to show low inflation no matter what is actually going on.
You are right to point out the problem with home owners equivalent rent. I’ve always considered it to be an extremely poor measure of the impact of housing on inflation that creates major distortions to the CPI.
But, when you look at the NSA CPI the housing component regularly appears as a bulge in the third quarter data rather than the first quarter data. The first quarter accounts for 55% of the CPI and the third quarter accounts for another 25%. The third quarter bulge is driven by three things, housing, tuition and new cars.